May 20, 2020
Director of Federal Tax Policy
May 20, 2020
The Health Economic Recovery and Omnibus Emergency Solutions (HEROES) Act includes important changes to business tax provisions in the CARES Act, the most recent COVID-19 legislation enacted by Congress and the president. The House-passed plan would undo CARES Act changes that make it easy for businesses to claim losses to reduce or avoid all taxes.
The details are technical, but the result is that the act would raise $250 billion over a decade by shutting down unnecessary tax giveaways to corporations and wealthy individuals.
Changes to Loss Rules for All Types of Businesses
One set of changes in the HEROES Act limits provisions in the CARES Act making it easier for businesses of any type to claim “net operating losses,” or NOLs. The CARES Act, which was enacted in March, makes three changes related to losses:
First, the CARES Act allows businesses to carry back losses in a given year to offset profits in previous years. It is unsurprising that Congress would allow this more generous rule for losses that businesses face in 2020, but the CARES Act also allows this retroactively for losses that businesses reported in 2018 and 2019, which have nothing to do with the COVID-19 crisis that the legislation is ostensibly addressing.
Second, while Congress might be expected to allow these losses to be carried back to offset profits from the previous two years (which was the rule before the Trump tax law was enacted), the CARES Act goes further by allowing these losses to be carried back five years. This creates enormous opportunities for corporations and other businesses to manipulate their losses to dodge taxes to take advantage of the fact that tax rates were higher before 2018.
Profits earned by businesses today are taxed at the low rates enacted as part of the Trump-GOP tax law. But, under the CARES Act, losses reported today can be deducted at the higher rates that were in effect before the Trump tax law went into effect if these losses are carried back to years before 2018. As ITEP has explained previously, taxing profits at one rate and allowing losses to be deducted at a higher rate is overly generous to corporations and other businesses and invites them to game the system to dodge taxes.
Third, the CARES Act allows losses carried back to offset up to 100 percent of profits in a given year, rather than the 80 percent limit in effect under the Trump tax law that applies to losses carried forward.
These changes are especially beneficial to industries with volatile profits, such as the energy industry, as explored in a recent Bloomberg article.
Congress’s official revenue estimator projected that these changes to NOLs, would reduce revenue by about $26 billion over a decade. Some observers suggest that the cost could be much higher given the amount of losses that businesses may report this year. Steven Rosenthal and Aravind Boddupalli at the Tax Policy Center point out that in 2008, at the height of the recession, businesses reported $1.6 trillion in losses. Allowing more generous deductions for such losses could incur a staggering cost.
The HEROES Act would significantly scale back the CARES Act provisions by allowing businesses to carry back losses from 2019 and 2020 (allowing one rather than two years of pre-COVID-19 losses). Most importantly, losses would not be carried back to years before 2018, meaning losses would not be deducted at higher rates than are imposed on profits today.
Changes to Loss Rules Specifically for Pass-Through Businesses
The other relevant change in the HEROES Act concerns losses claimed specifically by owners of pass-through businesses, which are businesses that do not pay the corporate income tax because profits are instead included on the personal income tax returns of their owners.
The 2017 Trump-GOP tax law bars pass-through owners from offsetting more than $250,000 of their non-business income (or $500,000 of non-business income in case of a married couple) with pass-through business losses.
This is one of the few provisions in the Trump-GOP tax law that makes a lot of sense. South Carolina School of Law Professor Clint Wallace recently explained how many of the “losses” reported by owners of pass-through businesses exist on paper only.
For example, Wallace explains that a pass-through business could be breaking even until, at the end of the year, the owner decides to purchase a $5 million machine for the business. The owner is not $5 million poorer but has merely traded $5 million in cash for a machine that is worth the same amount and is expected to generate profits in the future.
The owner could, nonetheless, report a $5 million loss for the year and use that to offset income from other sources. The only limit is the Trump law’s provision barring the owner from offsetting more than $250,000 of non-business income, or $500,000 of non-business income if married.
Other examples of paper losses involve owners who drain their business revenue by paying themselves a large salary and real estate investors who depreciate debt-financed rental properties even as their value increases.
The drafters of the Trump-GOP tax law were (uncharacteristically) right to limit deductions for these losses for pass-through owners, who are mostly high-income individuals.
The CARES Act, however, suspends the 2017 law’s limit on pass-through losses for 2020 and also retroactively for 2018 and 2019. The retroactive suspension obviously has nothing to do with the COVID-19 crisis that the CARES Act is ostensibly drafted to address.
Not surprisingly, the provision of the CARES Act mainly benefits the very rich. Congress’s official revenue estimator projects that 82 percent of the benefits of this change will go to those with incomes exceeding $1 million in 2020. The millionaires who hit this particular jackpot receive an average of $1.6 million from it.
The cost of this CARES Act provision is projected to be $135 billion over a decade. But, as with the net operating loss provision, the true cost could be much more depending on the amount of business losses that pile up this year.
The House Democrats’ HEROES Act would reverse the CARES Act provision by reinstating the limit on pass-through losses. The HEROES Act would then go even further. Like most personal income tax provisions of the Trump-GOP tax law, the pass-through loss limit expires at the end of 2025, but the HEROES Act would make it permanent.
The HEROES Act Would Correct Mistakes
The Trump administration seems reluctant to provide families with any more than the payments already made in the CARES Act, which come to $1,200 per taxpayer and $500 per child. Meanwhile, the same bill allows corporations to manipulate profits to dodge billions in taxes and allows millionaires who own pass-through businesses an average benefit of $1.6 million in 2020 alone. It is entirely reasonable that the HEROES Act would correct these mistakes and redirect resources to where they are needed.
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