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Loss Carrybacks Can Help Nonprofits but IRS Direction Is Limited

April 27, 2020, 5:23 PM

While recent IRS guidance provides nonprofits much-needed direction on using losses to lower taxable income from previous years, the agency will need to do more to help the entities take full advantage of the benefit.

The proposed rules (REG-106864-18) clarify the order in which nonprofits can use net operating losses (NOLs) from unrelated businesses—activities that are separate from a nonprofit’s core mission—to offset taxable income from previous years. The rules direct nonprofits to deduct pre-2018 NOLs first from total unrelated business income “in the manner that results in maximum utilization of the pre-2018 NOLs in a taxable year.”

But the IRS didn’t fully address how the rules should work with the recently enacted virus relief law (Public Law 116-136) known as the CARES Act. The law extends the time period in which an NOL can be used and lifts the 80% deduction cap. The IRS said it will continue to review how the law’s changes will affect calculation of unrelated business income, and it may issue additional guidance.

In the meantime, nonprofits are in a period of limbo, hesitant to use the perk without more IRS direction on how to do it. Compounding the problem is the economic fallout many large nonprofits are facing as a result of the pandemic, said Lloyd Hitoshi Mayer, a professor at University of Notre Dame Law School. The proposal comes at a time when large nonprofits need more clarity from the government, not more questions, he said.

“For some of these entities, this is make or break financially,” Mayer said. “They need every cent they can possibly come up with because they’re taking huge losses, furloughing employees, cutting back compensation, and cutting unnecessary expenses.”

Mayer also said the guidance could be an easy fix, but fears that other priorities may send any additional clarity to the back burner.

“I would worry that the guidance won’t be forthcoming and it will leave a lot of nonprofits in the balance,” Mayer said. “This is real dollars on the table; it’s going to cause another dilemma that Treasury could easily resolve.”

Benefit for Taxpayers

The rules require nonprofits to “silo” each source of income, calculating and reporting various items like food sales, ticket sales, income on rental property, and profit from franchise agreements separately.

The NOL provision allows nonprofits to apply the losses across all the silos, instead of separately, to maximize the benefit.

“The NOL provision is definitely taxpayer-friendly,” Chris Moran, an associate at Venable LLP, said. “It should help some organizations that have pretty significant pre-2018 NOLs.”

The rules are expected to benefit large nonprofits with a swath of income streams, like colleges and universities, museums, nonprofit hospitals, and some large foundations with investment income.

Moran projected that the IRS will likely issue guidance on the issue by the third or fourth quarter of this year, in time for nonprofits to file 2020 taxes.

Virus Do-Over?

Still, the guidance as whole still raises more questions than answers, said University of Miami Law School tax professor Frances Hill.

While Hill acknowledged the long journey the IRS took to release the rules, she said it would have been better for the agency to start from scratch, given the host of problems the coronavirus pandemic has wreaked on the economy and nonprofit sector.

Colleges and universities are grappling with lost revenues after sending students home and canceling sports events, and nonprofit hospitals are forgoing more lucrative elective surgeries to deal with a crush of Covid-19 patients.

“I really do not see what is expected to come out of this; especially now, when I imagine that so many exempt entities may no longer exist by this time next year,” Hill said.

To contact the reporter on this story: David Hood at dhood@bloomberglaw.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com

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