The Tax Cuts and Jobs Act of 2017 stopped businesses from carrying back any net operating losses (NOLs) and limited any NOLs carried forward to 80%. However, with the coronavirus pandemic affecting so many businesses across the globe, legislators revised net operating loss rules to give businesses a way to reduce their tax liability and reclaim much-needed funds. Below are the new rules for net operating losses under the Coronavirus Aid, Relief, and Economic Security (CARES) Act and how they could benefit you.
What is a net operating loss?
A net operating loss (NOL) occurs when you have more outgoing expenses than incoming revenue. Net operating losses can help reduce your tax bill.
New net operating loss rules according to the CARES Act
If you create NOLs in any taxable year between Dec. 31, 2017, and Jan. 1, 2021, you can carry back the losses to each of the five taxable years before the year of the loss. So, if you created a NOL in 2018, you could apply it to tax years 2013 – 2017.
If your NOL amount is more than your taxable income during the five-year carryback period, you can carry any remaining NOL amount forward. You have to apply the NOL to the fifth preceding year first then work your way forward to a more recent tax year.
Here’s an example: You have a $50,000 NOL for 2019. You must carry it back to 2014 first. Since you have no taxable income in 2014, you can apply it to 2015. In 2015, you had $40,000 in taxable income. You can apply $40,000 of your NOL to 2015. Then, you’ll carry the remaining $10,000 of the loss into 2016 or the next year with taxable income.Under the CARES Act, any losses you carry forward can offset 100% of your organization’s taxable income. If you’re able to do this, you could reduce your tax bill to $0.
How can I take advantage of the new NOL rules?
This ability to carry back losses can bring you additional cash flow during a revenue decline in the form of tax refunds, reduced estimated payments, or both. If you have any existing NOLs, it’s time to use them.
Generally, it’s most advantageous to carry back NOLs to tax years with the most tax liability. But you can’t pick and choose which years to apply the NOL. You must carry each NOL back to the fifth preceding year first. If any amount of the NOL remains after applying it to the fifth preceding year, you can carry the remainder to the fourth preceding year, then the third, then the second, then the first. You can waive your right to carry a NOL back, but then you have to carry the entire loss forward.
Because the NOLs from 2018, 2019, and 2020 stand on their own, you have to decide if you want to carry back each year’s loss or apply the NOL to future tax years. Once you make the decision, you can’t change it.
Usually, it’s better to carry a loss back because tax rates in previous years are higher than what they are or will be in future years (assuming current tax rates stay the same). If you don’t know what to do with your NOL, find out how much taxable income exists during the five-year carryback period. Next, determine the NOL amount available for carryback.
How to increase a NOL
If the NOL isn’t able to offset all of the taxable income in the carryback period, consider increasing the NOL. How? You have a few options.
The CARES Act included a correction to the Qualified Improvement Property rules. This correction allows certain improvements to the interior portion of nonresidential real estate to qualify for 100% bonus depreciation. You can apply this correction to property placed in service during 2018, 2019, and 2020, which may provide substantial tax deductions.
For the 2019 and 2020 tax years, a change in your accounting method may allow for additional deductions that increase the NOL. Take a look at the tax rules around accrued expenses, prepaid expenses, and inventory items. Will these rules increase your NOL? If you need assistance, contact a tax professional. Unfortunately, it’s too late to change your accounting method for 2018.
When NOT to carry back a loss
Carrying back a loss may be a bad move if it causes you to lose a permanent tax benefit in a previous year. For example, you could lose tax credits. If these credits expire before they can be used again, it may be better to carry the NOL forward. You could also lose your Domestic Production Activities Deduction (DPAD or Section 199 deduction). The Tax Cuts and Jobs Act repealed this deduction, so it’s no longer an option. But, it used to be a noncash deduction equal to 9% of the taxable income from the sale of goods produced in the U.S. If you carry back a loss into a year where you claimed the DPAD, some or all of that tax benefit will be lost.
How can I carry back a NOL?
If you choose to carry back a NOL, you can file an application for a tentative carryback adjustment for a prior taxable year with the IRS. Corporations can use Form 1139, Corporation Application for Tentative Refund. Other taxpayers can use Form 1045, Application for Tentative Refund. You may receive a quick tax refund if you apply for an adjustment, as the IRS will review your application and administer the credit or refund within 90 days of your application filing date.
If a loss arises in a tax year that begins after Dec. 13, 2017, and before Jan. 1, 2021, you can use Form 1139 or Form 1045 to carry back the loss. You must file the appropriate form within a year of the taxable year’s end. After the one year mark, you have to file an amended return. However, the IRS provided an automatic six-month extension for businesses that incurred losses in either the 2018 calendar year or during a fiscal year ending between Jan. 1, 2019, and June 30, 2019.
How can I apply NOLs to future tax years?
If you carry forward any NOLs, you can claim a tax deduction in those tax years. Your deduction amount will be equal to the sum of the NOL carryover and carrybacks in that year.
How can Beene Garter help?
We can help you understand how these rules apply to your tax situation so you can get the most money in your pocket. We’ll review past years’ tax returns. We’ll forecast. Offer recommendations on whether it’s best to carry NOLs forward or back. Then, we’ll help you file applications for carryback adjustments, file amended returns, or claim the deduction in future tax years. We’re here to help you take advantage of these new rules. You don’t want to miss any deadlines or make any errors. It’s a critical time to get it right and get the cash you need.
Have questions about how to take advantage of the new net operating loss rules? Let’s talk!