Congressional Research Service IN11240 (COVID-19: Potential Role of Net Operating Loss (NOL) Carrybacks in Addressing the Economic Effects)

Summary

A Congressional Research Service Insight, IN11240, by Mark P. Keightley, dated March 16, 2020, on the potential role of net operating loss (NOL) carrybacks in addressing the economic effects of COVID-19. It states that a number of industries, particularly travel and tourism and restaurants, may suffer losses in 2020. It explains that before 2018 businesses with losses could carry back NOLs to receive a refund for past taxes paid, that Congress had temporarily extended or enhanced carryback rules in past downturns and disasters, and that the 2017 tax revision (P.L. 115-97), commonly referred to as the Tax Cuts and Jobs Act, eliminated the ability to carry back losses. It discusses how allowing carrybacks could assist affected businesses.

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INSIGHTi

COVID-19: Potential Role of Net Operating
Loss (NOL) Carrybacks in Addressing the
Economic Effects

Mark P. Keightley
Specialist in Economics

March 16, 2020
A number of industries may suffer losses in 2020 as a result of the coronavirus disease 2019 (COVID-19)
outbreak. The travel and tourism industry, and restaurant industry, appear particularly susceptible at the
moment due to an uptick in canceled reservations and a reduction in bookings. Other industries are likely
to be impacted as well by a drop-off in consumer spending and a resulting reduction in profits, with the
impacts likely increasing if COVID-19 continues to spread.
Before 2018, businesses with losses could “carry back” net operating losses (NOL) and use them to
receive a refund for past taxes paid. On several occasions, Congress temporarily extended or enhanced the
carryback rules to assist businesses in times of general economic weakness, or in response to natural
disasters. Recent changes enacted in the 2017 tax revision (P.L. 115-97), commonly referred to as the Tax
Cuts and Jobs Act (TCJA), however, eliminated the ability to carry back losses. This Insight discusses
how allowing NOL carrybacks could potentially assist businesses impacted by economic weakness
associated with COVID-19.

Carrybacks and Carryfowards
When a business experiences a loss (or NOL, in tax jargon) it owes no tax in that year. Currently, a
business may use a loss to reduce future taxes by claiming it as a deduction against income earned in
some future year. This process is known as carrying forward a loss, and a business may carry a loss
forward indefinitely. Prior to the TCJA, businesses were able to use losses to obtain a refund for taxes
paid in the past two years, a process known as carrying back a loss. TCJA, however, eliminated the two-
year carryback. Businesses generally prefer to carry losses back rather than carry them forward because

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IN11240

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carrybacks produce a benefit sooner and with certainty, whereas carryforwards reduce taxes at some
uncertain time in the future.
An example may help demonstrate the mechanics of carrying back a loss. Suppose that a business earned
profits of $100 last year and paid taxes of $21 (i.e., the tax rate was 21%). This year the business incurred
a loss of $40 and thus owes nothing in taxes. If the business is allowed to carry back this $40 loss it can
receive a partial refund for taxes paid last year. It does this by recalculating its tax liability last year,
subtracting the $40 loss from its $100 in income and applying the 21% tax rate. The business would find
its recalculated tax liability for last year to be $12.60 ($60 x 21%). It would then receive as a refund the
difference between what it originally paid in taxes last year and its recalculated tax liability, or $8.40 ($21
- $12.60).

Expanded NOL Carrybacks: Past Experience
At various times, the NOL carryback period was modified to provide temporary or targeted tax relief. For
example, during the Great Recession, the American Recovery and Reinvestment Act of 2009 (P.L. 111-5)
and Worker, Homeownership, and Business Assistance Act of 2009 (P.L. 111-92) temporarily extended
the two-year carryback period to up to five years. In response to the destruction caused by Hurricanes
Katrina, Rita, and Wilma, Congress passed the Gulf Opportunity Zone Act of 2005 (P.L. 109-135), which
extended the carryback period from two to five years for qualified losses occurring in the Gulf
Opportunity Zone (or GO Zone). The Job Creation and Worker Assistance Act of 2002 (P.L. 107-147)
temporarily extended the NOL carryback period from two to five years for losses incurred in 2001 and
2002 to assist in the economic recovery.

Stimulative Effect of Loss Carrybacks
One feature of effective fiscal stimulus is the speed with which it can impact the economy. Loss
carrybacks suffer from one fundamental issue in this aspect: losses cannot be carried back until after the
end of the tax year. The reason is that tax losses are computed over a tax year, and not over a month or a
quarter. Additionally, some businesses suffering from short-term economic disruption may not benefit
from a NOL carryback if they earn a profit over their full year. Businesses that are reasonably confident
that they will be in a loss position at the end of the tax year, and that have (or have access to) technical tax
accounting expertise, may be able to adjust required estimated tax payments to reflect an expected loss
carryback and experience some relief. These will most likely be larger corporate taxpayers, and not
smaller businesses.
Still, because it is notoriously difficult to predict the economy’s performance, and because there is a great
deal of uncertainty about COVID-19, providing the ability to carry back losses may help support
businesses if economic weakness is prolonged. Businesses that ultimately incur losses at the end of the
tax year would be able to amend previous years’ tax returns and receive a partial refund. This could assist
businesses that struggled to make payroll or cover operating expenses, as well as those that took loans that
need to be repaid.
Another aspect of effective fiscal stimulus is the “bang for the buck” a given tax reduction or spending
increase produces. Economists quantify this notion with the use of fiscal “multipliers.” Fiscal policy
multipliers measure the change in economic output in response to a dollar change in taxes or a dollar
change in spending. Past estimates by the Congressional Budget Office (CBO) and Moody’s Analytics
suggest that the multiplier effects associated with NOL carrybacks are small when compared to other
policy options. CRS Report R45780, Fiscal Policy Considerations for the Next Recession, contains the
CBO’s and Moody’s estimates, and also reviews the potential effectiveness of a number of fiscal stimulus
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options that have been considered in response to recent economic slowdowns, including NOL carryback
modifications.
Separate from the stimulative effects of NOL carrybacks is the issue of whether carrybacks should be part
of the tax system’s underlying structure. Many economists would argue that allowing businesses to carry
back losses increases economic efficiency by reducing the distorting effect taxation has on investment.

IN11240 · VERSION 3 · NEW
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