Tax & Business Alert
– December 2023
537 words
Abstract: Whether a business is new or established,
losses can happen. The federal tax code may help soften the blow by allowing
businesses to apply losses to offset taxable income in future years, subject to
certain limitations.
Use the tax code to make
business losses less painful
Whether you’re operating
a new company or an established business, losses can happen. The federal tax
code may help soften the blow by allowing businesses to apply losses to offset
taxable income in future years, subject to certain limitations.
Qualifying for a deduction
The net operating loss
(NOL) deduction addresses the tax inequities that can exist between businesses
with stable income and those with fluctuating income. It essentially lets the
latter average out their income and losses over the years and pay tax
accordingly.
Eligibility for the NOL
deduction depends on having deductions for the tax year that exceed your
income. The loss generally must be caused by deductions related to your:
The following generally
aren’t part of the NOL determination:
Individuals and C
corporations are eligible to claim the NOL deduction. Partnerships and S
corporations generally aren’t eligible, but partners and shareholders can
calculate individual NOLs using their separate shares of business income and
deductions.
Limitations
Prior to the Tax Cuts
and Jobs Act (TCJA), taxpayers could carry back NOLs for two years and carry
forward losses 20 years. They also could apply NOLs against 100% of their
taxable income.
The TCJA limits NOL
deductions to 80% of taxable income for the year and eliminates the carryback
of NOLs (except for certain farming losses). However, it does allow NOLs to be
carried forward indefinitely.
If your NOL carryforward
is more than your taxable income for the year you carry it to, you may have an
NOL carryover. That’s the excess of the NOL deduction over your modified
taxable income for the carryforward year. If your NOL deduction includes
multiple NOLs, you must apply them against your modified taxable income in the
same order you incurred them, beginning with the earliest.
Planning ahead
The
tax rules regarding business losses are complex, especially the interaction
between NOLs and other potential tax breaks. We can help you chart the best
course forward.
Sidebar:
A limit on excess business losses
The Tax Cuts and Jobs
Act (TCJA) established an “excess business loss” limitation, effective
beginning in 2021. For partnerships or S corporations, this limitation is
applied at the partner or shareholder level, after applying the outside basis,
at-risk and passive activity loss limitations.
Under the rule,
noncorporate taxpayers’ business losses can offset only business-related income
or gain, plus an inflation-adjusted threshold. For 2023, that threshold is
$289,000, or $578,000 if married filing jointly. Remaining losses are treated
as a net operating loss (NOL) carryforward to the next tax year. That is, you
can’t fully deduct them because they become subject to the 80% income
limitation on NOLs, reducing their tax value.
Important: Under the Inflation Reduction Act, the
excess business loss limitation applies to tax years beginning before January
1, 2029. Under the TCJA, it had been scheduled to expire after December 31,
2026.
©
2023