What Federal Policymakers Can Learn from Business Tax Refunds in 2020

December 4, 2020

A new report by the Government Accountability Office (GAO) highlights the ways federal policymakers and the White House could build on the federal response to the coronavirus pandemic and economic downturn. As part of this report, GAO reviewed how the relief measures for businesses and individuals have worked through 2020, including information about tax refund applications sent to the Internal Revenue Service (IRS) by firms taking advantage of tax provisions in the CARES Act.

The CARES Act provided firms with several options to obtain additional liquidity to make it through the early stages of the pandemic and retain payroll, such as by reinstating net operating loss (NOL) carrybacks, creating a new credit to incentivize keeping employees on payroll, and the newly created Paycheck Protection Program (PPP), which provided forgivable loans through the Small Business Administration (SBA).

As of October 19th, GAO reports that about 14,000 firms had applied for NOL or alternative minimum tax (AMT) carryback refunds, and that two-thirds of refunds were for less than $100,000. The IRS processed these refunds within 40 days on average.

The Treasury Department also reported in October that corporate tax refunds increased by about $5 billion for the fiscal year ending September 30th, which is well below pace based on what the Joint Committee on Taxation (JCT) estimated last spring. JCT estimated that the corporate NOL carryback provisions within the CARES Act would generate about $80 billion in refunds.

Part of the reason NOL carryback refunds have been limited is because of administrative challenges. The IRS has started accepting tentative refund requests through electronic fax in addition to paper so firms can bypass IRS mail backlogs. However, many firms filed a Form 1040 by paper, which prevents them from filing an amended e-file return—a Form 1040-X—under the IRS’ current rules.

Having to file a paper amended return slows a firm’s ability to receive a tentative refund, as the IRS is still catching up from a mail backlog due to pandemic-related reductions in on-site activity earlier this year. As the GAO puts it, “Without the timely processing of paper-filed Forms 1040-X, some taxpayers’ Forms 1045 will be held “in suspense” and their CARES-Act-related NOL refunds cannot be issued.” On the corporate side, it is possible that NOL take-up will rise from $5 billion once the IRS backlog clears, though it may not reach the $80 billion estimated by JCT in the spring.

Another reason NOL refunds may have been limited is due to interaction effects with other parts of the tax code. Applying for a NOL carryback reduces taxable income, which can interact with other tax benefits. Additionally, the American economy recovered faster than originally projected as the year progressed, which may have mitigated the need by some firms to carry back their existing NOLs or limited new losses in 2020.

Take-up was similarly limited for the employee retention tax credit, with about 26,600 employers claiming the credit totaling about $4.5 billion in benefits. Part of the reason the employee retention credit had limited take-up was because employers were not permitted to claim the credit if the firm took out a loan through the PPP. The PPP was more popular for firms partly because it also permitted firms to cover non-payroll expenses in addition to keeping employees on the books.

Whether limited take-up of tax refunds for NOL carrybacks or other tax credits was due to administrative challenges, complexity related to determining whether it is worth taking advantage of the relief, or an unexpected upturn in economic conditions, policymakers should consider finding ways to simplify the administration of relief during future crises. This will help ensure the relief is timely and targeted, key components of any successful relief package for this crisis or crises in the future.

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A tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in tax refunds. Overpaying taxes can be viewed as an interest-free loan to the government.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.

The Alternative Minimum Tax (AMT) is a separate tax system that requires some taxpayers to calculate their tax liability twice—first, under ordinary income tax rules, then under the AMT—and pay whichever amount is highest. The AMT has fewer preferences and different exemptions and rates than the ordinary system.