Rules on Net Operating Losses Impacting Unrelated Business Income Change Again!

The Tax Cuts and Jobs Act  of 2017 (“TCJA”) made some changes to the net operating loss (“NOL”) carryback and carryforward rules, which has impacted exempt organizations with unrelated business activities.

If losses and deductions from unrelated businesses exceed unrelated business income in a certain year, a net operating loss deduction may be taken for the excess amount.

Prior to TCJA, losses could be carried back two years and then carried forward for 20 years. And, no limitation was placed on the amount of unrelated business taxable income (“UBTI”) that could be offset by losses.

TCJA provides that the determination of any NOL deduction will be computed with respect to each separate trade or business.  NOLs are only allowed for the specific trade or business from which the losses are derived and cannot be used to offset UBTI from other unrelated business activities.  For taxable years beginning after December 31, 2017, an exempt organization with more than one unrelated trade or business will require the calculation of NOLs separately for each such trade or business without regard to the $1,000 specific deduction.  Under a special transition rule, NOLs arising in a taxable year beginning before January 1, 2018 that are being carried forward are not subject to this new provision.

TCJA also provides that NOLs arising in a taxable year ending after December 31, 2017 may not be carried back, but are allowed to be carried forward indefinitely.  Also, the amount of post-2017 NOL that can be utilized in a single year is equal to the lesser of (1) aggregate NOL carryovers to such year, plus the NOL carrybacks to such year, or (2) 80% of taxable income (without regard to the NOL).  NOLs incurred in prior years (pre-2018 NOLs) are utilized in accordance with the rules in effect for the years they were incurred.  An organization with more than one unrelated trade or business which has pre-2018 NOLs may be able to take an NOL deduction against total UBTI.

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), enacted and signed into law by President Trump on March 27, 2020 in response to the COVID-19 pandemic, temporarily suspends changes to the NOL rules made in the TCJA.  The first change is that it temporarily removes the taxable income limitation, allowing NOL carryforwards to fully offset income.  For tax years beginning after December 31, 2017 and before January 1, 2021, the entity is eligible to offset 100% of taxable income in years prior to 2021 and 80% of taxable income in years after 2020.

The second change is a modification of rules relating to NOL carrybacks.  Under the CARES Act, NOLs arising in a tax year beginning after December 31, 2017 and before January 1, 2021 can be carried back to each of the five tax years preceding the tax year of the loss. 

For purposes of New York unrelated business income tax, the NOL deduction claimed by an exempt organization is the amount allowed for federal tax purposes, with the following exceptions:

1. The NOL must be adjusted to reflect the modifications of N.Y. Tax Law Sec. 292(a)(1) and 292(a)(2), which stipulate that unrelated business income tax imposed by the State of New York must be added to federal unrelated business taxable income, and any refund or credit for overpayment of the tax must be subtracted from federal business taxable income; and
2. The NOL deduction cannot include losses sustained during any year that the organization was not subject to New York unrelated business income tax; and
3. The NOL deduction cannot exceed the deduction allowable for federal tax purposes.

Since New York State is already decoupled from the Internal Revenue Code on the NOL provisions, it is very likely that the state will not adopt any of the federal CARE Act modifications.