|
|
Net Operating Loss (NOL) is a term business owners are more familiar with, as net operating losses are usually associated with running a business.
|
|
|
|
|
The fact of the matter is you don’t have to be a business owner to have an NOL. Individuals may also have an NOL from casualty and theft losses due to an event that's been declared a disaster by the U.S. president, or loss from rental real estate, royalties, partnerships, S corporations, estates, and trusts.
Small companies may have an NOL because of poor sales, increased expenses or mismanagement of resources.
Partnerships and S corporations generally cannot use an NOL, but partners or shareholders can use their separate shares of the partnership's or S corporation's business income and business deductions to figure their individual NOLs.
For income tax purposes, a net operating loss may be defined as a loss taken in a period where a company's or an individual’s allowable tax deductions are greater than its taxable income.
To determine if you have an NOL, you start with your adjusted gross income (AGI) on your tax return for the year reduced by your itemized deductions or standard deduction. This must be a negative number, otherwise there is no NOL for the year.
Your AGI already includes all the deductions you have for your losses. You then add back to this amount any nonbusiness deductions you have that exceed your nonbusiness income. These include the standard deduction or itemized deductions, nonbusiness capital losses, IRA contributions, and charitable contributions. If the result is still a negative number, then you actually have a net operating loss for the year.
Generally, an NOL may be considered a valuable asset because it can lower a company’s amount of taxable income. An NOL is first used to offset income in the year of the NOL, but if the NOL exceeds 80% of the income, then it can be used to offset income in future years.
However, a NOL carryforward does not reduce income subject to self-employment tax; only income subject to the marginal tax is reduced.
Whatever the cause of the loss, the value of the tax credit cannot be used to receive a tax refund, therefore provisions were put in place to allow the carryforward of net operating losses and, up to January 2018, the carryback of an NOL.
|
|
|
|
|
In the past, NOLs were able to offset 100% of taxable income. Business owners could “carry a loss back” meaning they could apply an NOL to past tax years by filing an application for refund or amended return. This enabled them to get a refund for all or part of the taxes they paid in past years. NOLs could generally be carried back two years.
The Tax Cuts and Jobs Act (TCJA) eliminated carrybacks for NOLs. Starting in 2018, an NOL could only be deducted against the current year’s taxes. However, a two-year carryback continued to apply for certain losses incurred by farming businesses.
Moreover, the TCJA permits taxpayers to deduct NOLs only up to 80% of taxable income for the year (not counting the NOL deduction). Any unused NOL amounts could be carried forward and deducted in any number of future years.
The TCJA also modified existing tax law on excess business losses by limiting losses from all types of business for noncorporate taxpayers.
An excess business loss is the amount by which the total deductions from all trades or businesses exceed a taxpayer’s total gross income and gains from those trades or businesses, plus $250,000, or $500,000 for a joint return.
Excess business losses that are disallowed are treated as a net operating loss carryover to the following taxable year.
|
|
|
|
The interplay of the excess loss rules and other existing rules such as the passive activity is also to be noted. Prior to the enactment of the excess business loss limitation, passive activity losses generated by the taxpayer were limited to the extent of passive income. The passive activity loss limitation remains in effect, however the excess business loss limitation imposes an additional restriction after the passive activity rules are applied.
Unused losses may be deducted in any number of future years as part of the taxpayer's net operating loss carryforward. This limitation was set to take effect in 2018 and scheduled to last through 2025.
The Coronavirus Aid, Relief, and Economic Act (CARES Act), signed into law by the President on March 27, 2020, provides further tax relief for taxpayers with net operating losses.
The CARES Act temporarily suspends retroactively changes made to the treatment of net operating losses by the TCJA. It also suspends retroactively the limitation on excess business losses added by the 2017 Tax Act.
|
|
|
The new NOL rules provide an opportunity for businesses to carry back a NOL to years where the tax rate on ordinary income was higher (35% versus the current rate of 21%). This might generate a tax refund for companies on taxes previously paid for 2018 and 2019 taxable years and thus provide immediate cash flow.
The CARES Act removes the limitation on excess business losses for taxpayers (other than corporations) for tax years beginning after December 31, 2017, and before January 1, 2021.
This will allow noncorporate taxpayers to offset taxable income by business losses for the 2018, 2019, and 2020 taxable years, even if those losses are not related to COVID-19.
|
|
|
|
|
| Revenue Procedure 2020-24 provides guidance to taxpayers with net operating losses that are carried back under the CARES Act for: |
|
- Waiving the carryback period in the case of a net operating loss arising in a taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2021,
- Disregarding certain amounts of foreign income subject to transition tax that would normally have been included as income during the five-year carryback period, and
- Waiving a carryback period, reducing a carryback period, or revoking an election to waive a carryback period for a taxable year that began before Jan. 1, 2018, and ended after Dec. 31, 2017.
|
|
In Notice 2020-26 , the IRS grants a six-month extension of time to file Form 1045, Application for Tentative Refund, or Form 1139, Corporation Application for Tentative Refund, as applicable, with respect to the carryback of a net operating loss that arose in any taxable year that began during calendar year 2018 and that ended on or before June 30, 2019.
Individuals, trusts, and estates would file Form 1045, and corporations would file Form 1139.
On April 8, 2020, the IRS issued Revenue Procedure 2020-23, allowing eligible partnerships to file amended partnership returns using a Form 1065, U.S. Return of Partnership Income, by checking the “Amended Return” box and issuing amended Schedules K-1, Partner’s Share of Income, Deductions, Credits, to each of its partners.
Partnerships filing these amended returns should write “FILED PURSUANT TO REV PROC 2020-23” at the top of the amended return.
Rules and regulations under the tax law have always been complex and complicated, but when major changes come into play as well, help from a tax professional becomes not just advisable, but necessary.
Keep up with our newsletters to find out about the most recent information which may impact your taxation and financial situation.
|
|
|
|
|
|
|
|
|
|
