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As we enter the final stretch of 2020, certain windows of opportunity are closing for many clients to lawfully reduce their taxes or obtain cash refunds of taxes paid. Here we focus on a big and soon-expiring opportunity for clients with heavily distressed assets or investments, and in net loss situations for 2020, which is all-too-common in the midst of Covid-19.
The opportunity, which is unique to 2020 and thus requires immediate attention, involves triggering losses in a manner to achieve ordinary loss treatment. Triggering losses at year-end is an annual ritual for many taxpayers. But for 2020 there’s a spin on this tradition.
The CARES Act amended Internal Revenue Code Section 172 to allow a 5-year carryback of net operating losses. Most ordinarily losses qualify for this 5-year carryback. This can turn today’s losses into immediate cash tax refunds. For many businesses that would be eligible to carryback losses, the cash tax refund is a needed life-line. But the 5-year carryback is only good for tax years beginning before January 1, 2021 (thus, for calendar-year taxpayers, the loss must be triggered by the end of 2020).
To benefit from the 5-year carryback provision, taxpayers and their advisors, as they evaluate losses to trigger in 2020, should review opportunities to lawfully structure gain recognition events to convert capital losses into ordinary losses (capital losses do not qualify for the 5-year carryback). Assets that have become worthless, or investments in business that have become balance sheet insolvent, are prime candidates. For example, worthless partnership interests, or partnership interests for which the built-in tax loss exceeds the value of holding the investment, should be evaluated.
But these opportunities must be analyzed carefully. The New York Times recently reported on a partnership loss that President Trump allegedly claimed in 2009 on an Atlantic City casino partnership. The report indicates that the Atlantic City casino partnership restructured in bankruptcy, after which President Trump received a 5% interest in a reconstituted partnership. If the report is accurate, this could arguably result in a capital, not ordinary, loss. In 2009, the 5-year carryback was not in play, but there were other potential benefits to ordinary loss treatment. The bottom line is that before an ordinary loss is claimed it behooves taxpayers and their advisors to meticulously plan and document the losses.
Many clients are ready to say good riddance to 2020. It’s been a brutal year. But a slice of economic salvation may reside in the Care Act’s 5-year carryback provision, and taxpayers are well-advised to consider their ability to benefit from it before it’s too late.