Tax Law Modifies Net Operating Loss Rules

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If your business losses in a year are larger than the total of all your other income and deductions, the excess is called a net operating loss (NOL). This loss may be carried to other tax years to reduce taxable income in those years. The Tax Cuts and Jobs Act (TCJA), signed into law by President Trump last December, significantly alters the treatment of these NOLs.

 

Carrybacks Eliminated; Carryforwards Don't Expire

Under prior law, an NOL in one year could be carried back to the two previous years. The earlier returns could be amended to deduct the NOL, and taxpayers could claim refunds for taxes they had already paid. Losses not absorbed over the previous two years were carried forward to reduce income for up to 20 years.

 

Under TCJA, the two-year carryback and the 20-year carryforward are eliminated for NOLs arising in tax years 2018 and later. Taxpayers are no longer allowed to carry back NOLs (there is a limited exception for farmers and certain insurance companies). Carryforwards, however, will no longer expire after 20 years - excess NOLs may now be utilized indefinitely until they are completely used up.

 

Taxable Income Limitation

Under previous law, NOLs could offset all taxable income. Taxpayers can now only utilize an NOL to reduce up to 80 percent of their taxable income in any given year. As a result, income will continue to create some tax even when a taxpayer has an NOL carryforward. Any unused NOL after the 80 percent limitation is applied will carry forward to the following year.

 

The 80 percent limitation is effective only for NOLs occurring in 2018 or later. Existing NOL carryovers that arose before 2018 continue to be fully deductible against 100 percent of income.

 

Coordination with Excess Business Losses

In last week's Tax Alert we explained a new provision that limits to $250,000 ($500,000 on a joint return) business losses individuals may use to reduce non-business items (such as wages or interest) on their return. Any loss limited by this rule is treated as an NOL carryover. The new NOL rules discussed above apply to this carryover; it can only be carried forward, it will never expire, and it is limited to 80 percent of taxable income in the year it is applied.

 

Update on Deduction for Pass-through Income

A previous Tax Alert explained TCJA's new 20 percent deduction for pass-through income. Many details remain unanswered, such whether specific types of businesses are eligible and how the wage and property limitations will be applied in certain circumstances. This week, the IRS announced that it expects to issue the first guidance on this deduction by the end of July.

 

Please call your LMC professional if your business has incurred or may incur NOLs. We can help you understand the impact of the NOL changes on your business and what steps need to be taken to better utilize your NOLs under the new law.

 

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