Congress Is Still Pushing to Undo Needed Fix to Net Operating Loss Deductions

Ever since the Coronavirus Aid, Relief, and Economic Security (CARES) Act passed back in March of 2020, Democrats have derided a provision affecting net operating loss (NOL) deductions as a handout to big businesses and the wealthy. Now, a letter signed by more than a hundred Democratic members of Congress is pushing once again to undo the change.

The Tax Cuts and Jobs Act, as a fundamental reform of the tax code, made many positive and forward-thinking changes. One less positive change, enacted primarily to allow Congress to make other positive reforms, were changes to net operating loss deductions for businesses.

Under the TCJA, corporations were prevented from carrying back NOL deductions, while the value of NOLs was capped at 80 percent of taxable income for any given year. Pass-throughs likewise saw NOLs capped, though this time at $500,000 for married filers (half that for single filers). 

In theory, though NOLs were limited in any given year, they could be carried forward against future years to still receive the full value of the deduction. The problem, of course, is when the pandemic hit, struggling businesses needed cash right then, not a few years down the line. The TCJA’s changes to NOLs had limited their flexibility to use the tax code to respond to crises.

After all, the whole reason NOL carrybacks and carryforwards are in the tax code to begin with is to allow businesses to smooth out their tax bills across good years and bad. Imagine a simplified scenario where a startup spends a year preparing for a product rollout — investing in product development, purchasing raw materials, and launching an advertising campaign. That next year, the company rolls out the product, receiving all the revenue that comes with a successful launch.

Without the ability to shift NOL deductions to different years, that business would be out of luck. Though it would be able to claim a NOL deduction for the year it spent preparing to roll out its product, it received no revenue that year — it didn’t even have a product yet. The next year, it would have to face tax on all the profits it earned, with no recognition from the IRS of the operating losses it had to incur the previous year in order to realize those profits. 

That would create all kinds of unhelpful incentives, encouraging businesses to avoid long-term investments and to never begin new projects before the beginning of the next tax year. Wherever possible, legislators should avoid structuring the tax code so as to incentivize unproductive tax code gaming. 

In recognition of these facts, and with the need to allow businesses to fully utilize the tax benefit of the NOL deduction even more apparent when businesses were suffering from lockdowns, Congress temporarily undid the TCJA’s changes with the passage of the CARES Act. Under the CARES Act, C corporation losses from 2018, 2019, and 2020 could be carried back up to five years. Pass-throughs saw the $500,000 (or $250,000) cap on NOLs lifted for those same three years. 

Nevertheless, Democrats have chosen to seize on this change as an opportunity to advance a continued narrative of a “rigged” tax code. Despite Democratic attempts to brand this change as a “giveaway” or “gimmick,” it’s an important part of a comprehensive response to the economic challenges the pandemic has presented.

Unsurprisingly, this is an entirely new bugaboo for Democrats. Democratic legislators vocally supported NOL carrybacks back under President Obama, and the Democratic opening offer prior to the CARES Act and the HEROES Act each contained provisions expanding NOLs

Once Democrats have received their desired social media clout from this unserious objection, hopefully Congress will move on to addressing actual issues, like the continued state efforts to tax out-of-state remote workers.