Net operating losses (NOLs) have traditionally been allowed as a deduction for businesses under IRC Section 172. The code stated that businesses will be allowed a deduction equal to the sum of the net operating loss carryforwards and carrybacks for the specific year. This allows a business to offset their taxable income by losses from either a prior year or future years to a degree. A business could carry back a net operating loss 2 years, or carry forward 20 years. NOLs could fully offset taxable income if not otherwise limited, such as through section 382 limitations. However, the taxpayer could also be subject to an Alternative Minimum Tax, which limited the usage of NOLs.
These rules have changed under the Tax Cuts and Jobs Acts (“The Act”), which altered the fundamental assumptions underlying how NOLs may be used and how much can be used at a time.
The Act made two major amendments to NOLs.
Net Operating Loss Carryback and Carryforward Provision
First, carrybacks of NOLs are disallowed and carryforwards can extend into perpetuity. This rule applies to any NOLs in taxable years ending after December 31, 2017. This specific date applies to fiscal year ends as well; for example, a year end of March 31, 2018 will be affected as their year-end is after December 31, 2017.
These rules will take effect for NOLs occurring in taxable years ending after December 31, 2017, so any NOLs ending in years prior to this date can still be carried back 2 years or forward 20, and may offset 100% of income.
An exception to the carryback disallowance exists for insurance companies and farming businesses, who generally will maintain the 2-year carryback.
Net Operating Loss Income Limitation
Second, a taxpaying entity can now only utilize an NOL for up to 80% of their taxable income in any given year rather than offsetting all taxable income. This applies only to NOLs in years that begin after December 31, 2017.
Taxpayers are limited to the lesser of the total available NOL or 80% of the taxable income in the specific taxable year. Any excess NOL is carried forward until it is completely used up. NOLs carried forward will not be increased by an interest factor. This allows for the NOLs to retain their value throughout any years carried forward.
Additionally, the Alternative Minimum Tax was repealed for corporations, and therefore, there will not be any further reductions, aside from this 80% limitation.
How Do the Net Operating Loss Changes Impact Your Situation?
As with many of the tax changes in the Act, some will benefit from this change while others may not.
Taxpayers will lose out as they will no longer be able to carryback the NOLs incurred in future years, but many will benefit from the indefinite carryforwards of their future NOLs as well. The impact may likely not be realized for several years down the road, and it’s exciting to see how the changes will take place.
If you have any questions or concerns, call the Freed Maxick Tax Team at 716-847-2651 to discuss your tax situation.