Stimulus package provides vital tax relief for business losses | American Enterprise Institute
In December 2017, I warned that provisions in the tax bills moving through Congress would artificially penalize risky business investments by letting the government play “Heads I Win, Tails You Lose” — immediately taxing profits when the investments pay off, but delaying deductions for losses when the investments go bad. Unfortunately, those provisions were included in the Tax Cuts and Jobs Act (TCJA) when it was adopted later that month.
In a welcome step, the stimulus package that the Senate unanimously approved Wednesday night offers temporary relief from the TCJA provisions. The tax relief gives businesses badly needed liquidity during the coronavirus pandemic while also reducing the tax penalty on risky business investments.
To understand the issues,
consider a corporation that earns a $100 profit each year for five years, but
loses $500 in the sixth year. Because the corporation has no net income over
the six-year period, it should pay no net tax over that period. So if the corporation
is taxed on the $500 it made in the first five years, it should be able to
deduct the $500 it lost in the sixth year. Also, because a dollar tomorrow is
worth less than a dollar today, the deduction should be provided as quickly as
The TCJA provisions deny
the corporation any immediate tax relief for its loss. The corporation obviously
pays no tax in the sixth year because it has no income, but it cannot deduct its
$500 loss at that time. Instead, the corporation must “carry forward” the loss to
future years, deducting it against any future profits it may earn. Even then,
the deduction can only offset 80 percent of each future year’s profits. Although
the corporation is likely to eventually deduct the loss, the delayed deduction
is worth less than an immediate deduction. The uneven treatment — immediate
taxation of profits and delayed deductions for losses — penalizes risky
The stimulus package
allows losses incurred in 2018 through 2020 to be “carried back” for up to five
years. In other words, the corporation can retroactively deduct the loss
against any profits it earned in the five previous years and claim an immediate
refund of past taxes paid on those profits. In the example, the corporation
could get an immediate refund in the sixth year by deducting the $500 loss
against its previous profits. (A corporation with a loss bigger than its
cumulative profits in the previous five years must carry forward the remainder.)
Before the TCJA provisions were adopted, losses could be carried back, but only
for two years.
Giving corporations refunds now for their 2018, 2019, and 2020 losses rather than making them wait to reap tax savings from carry forwards offers businesses an immediate cash infusion, helping meet liquidity needs during the pandemic. It is unsurprising that the OECD included loss carrybacks in its recent list of pandemic tax policy options.
Aside from meeting pressing liquidity needs, the loss carryback provision reduces the tax penalty on risky business investments. The stimulus package rightly omitted a provision in the House stimulus proposal that would have denied loss carrybacks to some businesses that pay high executive salaries or buy back their stock. Businesses should not face such restrictions merely to obtain neutral tax treatment of their investments. (The stimulus package does impose salary and buyback restrictions on businesses that accept government loans and grants.)
Because the loss carryback provision promotes tax neutrality, it should be made permanent. A permanent extension would also solve another problem — tax planners are reportedly urging companies to artificially accelerate their 2021 expenses into 2020 because 2020 losses, but not 2021 losses, can be carried back. The stimulus package’s loss carryback provision gives businesses valuable liquidity during the pandemic and provides more neutral tax treatment of risky business investments.