Tax Tip – Net Operating Losses

Don Fitch CPA Tax Tip

Generally, a net operating loss (NOL) is the amount by which your business deductions exceed your business gross income. An NOL sustained in tax years beginning before 2018 can be carried back and carried forward to other tax years and deducted against your gross income in those years. An NOL sustained in tax years after 2017 can generally just be carried forward, although there is an exception which allows carrybacks for farm losses.

Although NOLs are generally sustained only with respect to business operations, for tax years before 2018, individual taxpayers may also sustain NOLs as the result of casualty or theft losses, whether or not the casualty or theft losses involve business property. However, any personal casualty loss which would otherwise be deductible in tax years 2018-2025 is only allowed as a deduction in those years to the extent it is attributable to a federally declared disaster. This rule does not affect deductions for business-related casualty and theft losses.

For tax years before 2018, the amount of NOL you sustain in a tax year is equal to the excess of your deductions for the year over your gross income for the year, with the following modifications:

(1) No net operating loss deduction is allowed. Thus, in determining the amount of your NOL for the current year, you must add back any deduction you take for NOL carrybacks or carryforwards from other years.

(2) No deduction is allowed for personal exemptions. Thus, in determining the amount of the NOL for the current year you must add back any deduction you took for personal exemptions.

(3) No deduction is allowed for the amount of any capital losses in excess of capital gains. In other words, capital losses are allowed only to the extent of capital gains. Thus, in determining the amount of your NOL for the current year, you must add back any capital loss deduction you took.

(4) The exclusion for a percentage of the gain from the sale or exchange of qualified small business stock is not allowed. Thus, in determining the amount of your NOL for the current year, you must add back any such gain that you excluded from income.

(5) The domestic production activities deduction is not allowed. You must add this back in determining the amount of your NOL for the current year.

(6) No deduction is allowed for the amount of any nonbusiness deductions in excess of nonbusiness income. In other words, nonbusiness deductions are allowed only to the extent of your nonbusiness income. Any excess nonbusiness deductions must be added back in determining the amount of the NOL for the current year. This effectively limits NOLs to losses you sustain in a trade or business. However, for NOL purposes, all casualty or theft losses are treated as attributable to a trade or business, even if they involve nonbusiness property. Thus, even if you do not operate a trade or business, you may have an NOL for the tax year if you have casualty or theft losses.

For tax years after 2017, the amount of NOL you sustain in a tax year is equal to the excess of your deductions for the year over your gross income for the year, with the following modifications:

(1) No net operating loss deduction is allowed.

(2) No deduction is allowed for the amount of any capital losses in excess of capital gains. In other words, capital losses are allowed only to the extent of capital gains. Thus, any capital loss deduction must be added back in determining the amount of the NOL for the current year.

(3) No exclusion is allowed for the Code Sec. 1202 gain from the sale or exchange of qualified small business stock that is excludible from income. Thus, any such gain excluded from income must be added back in determining the amount of your NOL for the current year.

(4) To the extent that otherwise allowable deductions are not attributable to your trade or business, they are allowed only to the extent of the amount of the gross income not derived from such trade or business.

After determining the amount of the NOL you sustained in the current tax year, you must determine the tax years to which you can carry that NOL. The NOL can be used to offset taxable income in those years. A carryback of an NOL generally results in a refund of federal income tax paid for the carryback year. A carryforward generally reduces your federal income tax liability for the carryforward year. Generally, for NOLs incurred before 2018, you must carry back the NOL from the current year (the so-called loss year) to the two tax years before the loss year (the carryback period), and then carry forward the NOL to each of the 20 years following the loss year (the carryforward period). However, there are a number of exceptions to the two-year carryback period. The carryback period is three years for NOLs from certain casualty losses, five years for certain farming losses and certain disaster losses, and 10 years for certain specified liability losses. Also, you can elect to waive the carryback period for any NOL and instead just carry forward the NOL for the 20-year carryforward period. Special rules apply in calculating NOL carrybacks and carryforwards when you have had a change of marital or filing status.

Generally, for NOLs incurred after 2017, the loss is carried forward indefinitely. In the carryover year, the amount of the loss that can be deducted in the lesser of the net operating loss carryovers to such year or 80 percent of taxable income computed without regard to the deduction allowable. The only provision for a carryback of a loss is if you incur a farming loss. In that case, the loss is carried back two years, although there is a provision that allows you to elect not to carry the loss back and instead carry it forward.

Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.

DON FITCH, CPA
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This blog post is intended to serve solely as an aid in continuing tax education for Don Fitch Accountancy blog and email members. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any federal tax, accounting opinion, tax return position, and must be supplemented for such purposes with other current authoritative materials. The information in this blog post has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, Don Fitch Accountancy is not engaged in rendering legal or other professional services and will not be held liable for any actions or suits based on this blog post, email, or comments made during the above presentation. If legal advice or other expert assistance is required, seek the services of a competent professional.

(Updated 02/27/2021 13:18)

Published by Don Fitch, CPA

Offers in Compromise, Wage Levy Releases, Installment Agreements, IRS Audits, and much more IRS assistance. Also, allow us to Help you complete your Tax Returns from 1913 to present (100+ Years) and for any of the 50 States.

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