As a company’s deductible expenses outpace its income, a net operating loss (NOL) typically takes place. As you file your 2017 income tax return, should you discover your business had an NOL, at least one positive outcome ensues: tax benefits. But bear in mind that the Tax Cuts and Jobs Act (TCJA) has made considerable adjustments to the tax treatment of NOLs.
Before TCJA, the law allowed a business NOL to be carried back up to two years, while the outstanding amount could be carried forward up to 20 years. The carryback can produce an instant tax refund, increasing cash flow.
As an alternative, the business can choose to carry the entire loss forward. This works to one’s advantage when cash flow is strong and the business’s income has risen significantly, pushing it into a higher tax bracket — or if tax rates go up. In both cases, the carryforward can save more taxes than the carryback since deductions are more effective in situations involving higher tax rates.
But, starting with the 2018 tax year, the TCJA has set a flat 21% tax rate for C corporation taxpayers, and the rate has no expiration date. As a result, C corporations won’t need to fret over being pushed into a higher tax bracket (at least until the next time Congress alters the corporate rates).
Another thing to remember is that the rules become more complicated for pass-through entities, like S corporations, partnerships and limited liability companies (when they elect partnership tax treatment). Each owner’s allocable share of the entity’s loss is passed through to the owners and reported on their personal returns, and their tax benefit will be determined by each owner’s individual tax situation.
The TCJA changes
By and large, the TCJA adjustments to the tax treatment of NOLs are not beneficial to taxpayers:
- For NOLs taking place in tax years ending after December 31, 2017, you cannot carry back a qualifying NOL at all. This may be particularly damaging to start-up businesses, as they are more inclined to generate NOLs in their early years and can greatly benefit from the cash-flow boost of a carried-back NOL. (On a positive note, the TCJA permits NOLs to be carried forward indefinitely, instead of the previous limit of 20 years.)
- For NOLs taking place in tax years beginning after December 31, 2017, an NOL carryforward typically cannot be applied to shelter over 80% of taxable income in the carryforward year. (Typically, up to 100% could have been sheltered under prior law.)
It’s possible that the discrepancies among the effective dates for these changes were a mistake, and Congress could make a technical correction. Also, with regards to pass-through entities, keep in mind that owners’ tax benefits from the entity’s net loss might be further limited under the TCJA’s new “excess business loss” rules.
Complicated rules get more complicated
NOLs can yield significant tax benefits. Unfortunately, the ever-complex rules have become even more complicated under TCJA. Please contact us or call 818-334-8623 if you want to learn more about NOL rules and the best way your business can maximize NOL tax benefits.