TCJA’s NOL limitations rolled back in congressional COVID-19 response

On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). Passed in response to the economic repercussions of the COVID-19 pandemic, the CARES Act makes a number of significant changes to the I.R.C., including rolling back certain limitations on the utilization of net operating losses (NOLs) that were put in place by the Tax Cuts and Jobs Act (the TCJA). Because of states’ differing rules on NOLs and conformity to the I.R.C., the CARES Act’s changes to the federal NOL rules will have varying SALT implications.

NOLs pre-TCJA

Prior to the TCJA, subject to the application of the alternative minimum tax (which was repealed by the TCJA), companies could fully offset their current year taxable income with NOL carryforwards. NOLs could also be carried back two years and carried forward twenty years to offset, without limitation, taxable income in those years.

NOLs post-TCJA

The TCJA amended I.R.C. § 172 by putting in place an 80% limitation (determined without regard to the deduction) on the deductibility of loss carryforwards arising in taxable years beginning after December 31, 2017. The TCJA also eliminated the historic rules allowing a two-year carryback of NOLs, while expanding the NOL carryforward rules to permit unlimited carryforwards for losses arising in taxable years beginning after December 31, 2017.

The effect of the 80% NOL limitation was that companies could not fully offset their current year taxable income with carried forward NOLs from taxable years beginning after December 31, 2017 (NOLs from taxable years beginning before January 1, 2018 could be utilized to offset 100% of taxable income), generally ensuring a 4.2% minimum rate of tax for any profitable year.

NOLs post-CARES Act

• Elimination of the 80% Limitation: Captioned as “The Temporary Repeal of Taxable Income Limitation,” the CARES Act repeals the 80% NOL limitation for taxable years beginning before January 1, 2021. Companies are now permitted to fully offset their taxable income in such taxable years with NOL carryforwards without regard to the year in which such NOL arose.
  • NOLs from taxable years beginning after December 31, 2017 that are carried forward to taxable years beginning after December 31, 2020 will be subject to the 80% limitation that was enacted as part of TCJA.
• Reinstatement of NOL Carrybacks: The CARES Act reinstates loss carrybacks for NOLs arising in 2018, 2019, and 2020 (taxable years beginning after December 31, 2017 and before January 1, 2021), to the five taxable years preceding the taxable year in which the loss arose. Taxpayers generally have at least 120 days following enactment of the CARES Act either to carry back their 2018 NOLs or to relinquish the carryback period and carry such amounts forward.

SALT Implications of Federal NOL Changes

The changes to the federal NOL limitation, carryforwards, and carrybacks will result in varying consequences to the states:

• Some states explicitly adopt the federal NOL deduction by use of line 30 of federal Form 1120 (taxable income after the NOL deduction and special deductions) without modification as the starting point for determining state taxable income.
• Other states use line 30 as the starting point of federal Form 1120, but add back the federal NOL deduction and provide a separate computation to calculate the state NOL deduction.
• Still other states begin the tax calculation with line 28 of federal Form 1120 (taxable income before NOL deduction and special deductions) and provide their own set of rules for determining the NOL deduction.

To the extent a state conforms or partially conforms to the federal NOL rules, there remains the question of which version of those rules is applicable. Some states conform to the I.R.C. on a rolling basis (e.g., Illinois and New York). These states—unless they otherwise decouple from the impacted I.R.C. provisions—automatically conform to the CARES Act, including the changes to NOLs. Other states conform to the I.R.C. based on a fixed date (e.g., Georgia and Virginia) or selectively conform (e.g., California and Pennsylvania). In those states, an affirmative change to the state’s statute would be required for the NOL changes contained in the CARES Act to apply.

Regardless of conformity to line 28 or 30, the reintroduction of a federal carryback for NOLs arising in 2018, 2019, and 2020 does not necessarily mean that companies can carryback NOLs at the state level. This is due to states’ historic deviation from the federal carryback/carryforward rules. A recent example of this is California, which in 2019 amended its law to disallow NOL carrybacks (with limited exceptions) for taxable years beginning after December 31, 2018. California still permits a two-year carryback for NOLs attributable to taxable years beginning on or after January 1, 2013, and before January 1, 2019. There is, however, the opportunity for California, or any other state, to conform to, or enact measures similar to, the federal NOL carryback rules contained in the CARES Act.

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