Not all losses are created equal.
The rules surrounding net operating losses (NOLs) have changed quite a bit over the last few years and tax planning opportunities are ripe.
Due to the COVID-19 economic downturn, many companies faced significant net operating losses in 2020. The Tax Cuts and Jobs Act (TCJA) passed in 2017 provided that NOL carryovers generally were allowed for a taxable year up to the lesser of (1) the carryover amount or (2) 80 percent of taxable income determined without regard to the deduction for NOLs. NOL carrybacks of post-2017 tax years were eliminated.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act (2020) amended the TCJA and allowed NOLs arising in a tax year beginning after December 31, 2017, and before January 1, 2021, to be carried back to each of the five tax years preceding the tax year of such loss. It also suspended the taxable income limitation in the TCJA to allow an NOL to fully offset income. The intent of the CARES Act was to allow companies to utilize losses and amend prior year returns, thereby providing increased cash flow during the COVID-19 crisis.
For taxable years beginning before 2021, taxpayers were eligible for an NOL deduction equal to 100% of taxable income. For taxable years beginning after 2021, the taxpayer will be eligible for a 100% deduction of NOLs arising in tax years prior to 2018 and will be eligible for a deduction limited to 80% of modified taxable income for NOLs arising in tax years after 2017.
A summary of the rules are as follows:
|NOL Generated in Tax Years||Eligible for Carryback||Eligible for Carryforward||Eligible to Offset % of Taxable Income|
|Beginning on or before 12/31/17||2 tax years||20 tax years||• 100% of taxable income|
|2018-2020||5 tax years||Indefinite||
• 100% of taxable income prior to 2021
•80% of taxable income after 2020
|2021 and beyond||Generally, no carryback||Indefinite||• 80% of taxable income|
Planning Opportunity for Corporate NOLs
A significant planning opportunity exists for corporations who experienced NOLs in 2020 but had profits in previous years. However, taxpayers should be mindful that the carryback of NOLs could impact deductions and credits that were previously claimed in prior tax years. Deductions that are limited to taxable income (such as Section 179 elections to expense depreciable assets, or domestic production activity deductions) would be negatively impacted by any NOL carryback, so the taxpayer should consider these implications when planning NOL usage.
Excess business loss limitations
The excess business loss limitation, codified in Internal Revenue Code section 461(l), was originally created by the TCJA. Section 461(l) went into effect for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, making 2018 through 2025 filings subject to the limitation. However, the CARES Act retroactively delayed the implementation of section 461(l) from tax years beginning after Dec. 31, 2017, to tax years beginning after Dec. 31, 2020, in order to offer relief to taxpayers experiencing financial difficulty due to COVID-19. The American Rescue Plan Act of 2021 (ARPA) subsequently extended this provision for one year, to include tax years beginning before January 1, 2027.
Thus, the excess business loss limitation is now in effect for taxable years beginning after December 31, 2020, and before January 1, 2027, and, for taxpayers other than corporations, effectively limits the amount of trade or business deductions that can offset nonbusiness income.
An excess business loss is the amount by which the total deductions attributable to all of your trades or businesses exceed your total gross income and gains attributable to those trades or businesses plus a threshold amount adjusted for cost of living. For taxable years beginning in 2021, the threshold amounts are $262,000 (or $524,000 in the case of a joint return). Net business losses in excess of this amount will be disallowed and carried forward.
The limit is applied at the partner or S corporation shareholder level and calculated after application of the passive activity loss and at-risk limitations. Net trade or business losses that exceed the threshold amount are carried forward as part of the taxpayers’ net operating loss (NOL) carryforward to subsequent taxable years.
Taxpayers who had a limited loss in either 2018 or 2019 can file an amended return and receive a refund.
However, going forward, careful consideration should be given to these limitations during tax planning.
Trish Casdorph, CPA, is Co-Director of our Business and Tax Advisory Group. She can be reached at firstname.lastname@example.org.