One Small Change in the Tax Code Could Help Many Businesses in Uncertain Time

In response to coronavirus, people are staying home,
canceling flights, postponing vacations, and not eating out.

All the businesses that were counting on those customers over
the next several months will struggle to pay their lenders, keep paying their
employees, and eventually to stay open at all.

One small change in the tax code could provide a lot of help
to businesses big and small. Companies should be able to make full use of any
losses on past years’ tax returns, giving them quick cash to bridge the coming
months of economic uncertainty.

In years when businesses are not profitable, the tax code
allows net operating losses (called NOLs) or negative profits to be carried
forward to future years and used to offset subsequent positive taxable profits.

In good times, this allowance is usually thought of as a way
to help fledgling businesses that take a year or more to get off the ground.

Say a new startup spent $100 in its first year but did not
earn a single penny because it was developing and perfecting products. The
business lost $100 in the first year. The following year, it made $100 in
profit after finally opening its doors.

By allowing the first-year loss to offset the second-year
profits, the tax code essentially enables businesses to average their profits
and losses over time. In this example, the company can “carry forward”
its losses.

But net operating losses are not just for startups. They can
function as an important safety valve for businesses that lose money in an
economic downturn.

Following the 2017 tax cuts, businesses generally are prohibited
from carrying net operating losses back to previous tax years (essentially
claiming a credit against previous years’ positive gains and taxes paid), and
NOL carryforwards are limited to 80% of net income. For many small and medium privately
owned businesses, NOLs are limited
to as little as $250,000 a year.

By not letting struggling businesses credit their current
losses against past taxes paid, the current NOL system provides benefits that
are too little, too late.

When businesses need cash to make payroll and pay creditors
today, the NOL benefit on future-year tax returns is little help. By allowing companies
to refile past years taxes with a current year loss deduction, they can receive
a direct refund from the IRS of taxes they already have paid.

Congress should allow net operating losses to be carried
back for an immediate refund for two or more years. If companies choose instead
to carry their losses forward to future tax years, the 80% limitation and other
loss limitation rules should be removed. Congress has made similar
adjustments
to NOL rules in past economic downturns, most recently in 2009.

For even more immediate relief for the hardest-hit
industries, such as airlines and hospitality services, Congress could consider
allowing a temporary carryback of estimated future losses and make all losses refundable.

Many businesses don’t have existing losses waiting to be
credited; their losses are still in the future. For these companies, Congress
could allow them to estimate the coming year’s losses given simplified rules
assuming several months’ worth of significant disruptions. These estimated
losses also could be carried back for an immediate refund, injecting much-needed
cash into struggling industries.

For example, if a business had $500 in profits last year and
paid $100 in taxes on those gains, but anticipates having $500 in losses this
year, it could carry back those estimated 2020 losses and receive a $100 credit
today against previous taxes paid.

Estimated losses and actual losses or profits would be
reconciled at the end of the tax year, once the immediate economic
uncertainties have subsided.

Congress also should delay quarterly estimated tax payments
and filing requirements for all taxpayers to allow businesses and self-employed
workers to keep more of their own money to bridge the temporary decline in
commerce.

The first quarter of 2020 estimated taxes are due April 15, and
underpaying estimated taxes can lead to significant penalties. Congress should automatically
allow businesses and self-employed workers (without filing) to delay their
estimated tax payments until the third-quarter Sept. 15 deadline at the
earliest or entirely eliminate estimated tax payments, filing, and associated
penalties.

Businesses still could file tax forms if they expect to
benefit from the paid sick and family leave credits Congress is likely to pass.
They just would not have to pay any positive taxes due until at least the third
quarter.

Treasury Secretary Steven Mnuchin already has announced
interest and penalties will be waived for 90 days from the April tax filing
deadlines, but has not delayed filing. Filing requirements also should be
delayed.  

Expanding access to net operating losses will allow
struggling businesses to benefit more quickly from existing safeguards in the
tax code that allow income taxes to be smoothed over the business cycle.

Smoothing tax liability over time is not a bailout; it is
sound economic policymaking in good times and in times of economic uncertainty.

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