Should Congress manipulate the timing of business tax benefits to support firms in the midst of the COVID-19 economic slump? And if so, how?
That debate may be the next big battleground as Congress begins to focus on a new round of economic relief. The Coronavirus Aid, Relief, and Economic Security (CARES) Act started down this road by allowing firms to use recent year net operating losses (NOLSs) to get refunds for taxes they paid as far back as seven years ago. Even as Democrats want to roll back that provision, some GOP lawmakers are backing another change: They want to let businesses claim tax credits in 2020 that they otherwise would not be able to take until future years.
Here is a quick look at each of the ideas.
NOL Carrybacks. The CARES Act allows firms to use NOLs from 2018, 2019, and 2020 to claim refunds for taxes they paid as far back as five years before their losses. Thus, a firm that lost money in 2018 could reduce up to 100 percent of its taxable income for past years as far back as 2013. And because corporate income tax rates were as high as 35 percent before 2018, compared to today’s 21 percent, allocating those losses to pre-2018 tax years would produce a much more generous benefit.
The congressional Joint Committee on Taxation estimates that Treasury would pump about $87 billion into corporate coffers in 2020 and 2021 due to those changes. (Firms effectively would repay three-quarters of that amount back to Treasury by 2030 since they could no longer use those losses to offset future income).
While Congress adopted the NOL carryback provision with little debate, Democrats have been sharply critical of the measure ever since, insisting it is overly generous and ill-targeted. One major objection: Because the carryback benefits would be available for firms that lost money in 2018 and 2019, it effectively rewards business that suffered losses that had nothing to do with the COVID-19 pandemic.
The HEROES Act, passed by the Democratic-controlled House in May, would scale back much of that NOL relief. It would bar loss carrybacks before tax year 2018 and prohibit firms that bought back large amounts of their own stock or paid generous executive compensation from using the provision. It also would limit the ability of pass-through businesses to claim these losses against past-year individual income tax liability. The GOP-controlled Senate, however, has signaled it will not act on another relief bill until July and has shown little interest in revising the NOL measure.
Refundable business tax credits. This is another way to use the tax code to get money into the hands of cash-strapped businesses. Firms that owe no tax this year could cash out tax credits they otherwise may not be able to claim until some future year.
Businesses currently can claim scores of income tax credits for a range of activities, including research costs and investments in low-income housing and renewable energy. But under current law, business tax credits generally are not refundable (though some smaller businesses can use the research and experimentation tax credit to offset payroll taxes).
In other words, a firm cannot claim a credit that brings its income tax liability to below zero and generates a cash payment from Treasury. Instead, it must defer credits in excess of tax liability to a future year when it does owe taxes. It also may carry unusued credits back one year.
The research subsidy is the biggest of these credits. But in 2016, the IRS estimated that half of all research credits were unused in the year the expense was incurred.
In 2020, when many firms may have no taxable profits, it seems tempting to allow businesses to accelerate their credits. Compared to last year, corporate income tax revenues fell by nearly one-quarter through May.
Several countries in Europe and elsewhere do have refundable business credits. The US generally does not, through Treasury has allowed firms to convert some minor energy tax credits to grants, effectively making them refundable.
Now, encouraged by business lobbyists, some GOP lawmakers would make many business credits fully refundable—at least for 2020. The most prominent proponent of this idea is senior House Ways & Means Committee Republican Kevin Brady (R-TX). However, Jeff Stein of The Washington Post reports that some GOP members of the Senate Finance Committee are shopping the idea to colleagues as well.
Democrats are less than enthusiastic, in part because they worry about fraud and abuse. For example, it would be easy for someone to open a business, claim a fistful of tax credits, then shutter the firm. Others say because the Fed and Treasury already have opened the spigot to business lending, it is unnecessary to further boost business liquidity by making tax credits refundable.
Thus, we are setting the stage for a fascinating fight: Should Congress scale back its earlier effort to adjust the timing of tax preferences? Should it double-down on the idea? Or should Congress look outside the tax code for ways to deliver targeted relief to business?
