Squeeze the most out of net operating losses

The new Tax Cuts and Jobs Act (TCJA) reduces the tax benefits of net operating losses (NOLs) claimed by businesses.

Strategy: When possible, time NOLs to your tax advantage. Depending on your situation, you may be able to avoid the new law crackdown.

In particular, companies operating on a fiscal year basis may have more leeway than calendar-year entities.

Here’s the whole story: Previously, you could carry back an NOL for two years and then forward for up to 20 years. However, if it suited your purposes, you could elect to forgo the carryback.

The exact mechanics depended on the form of business ownership. For instance, if you owned a C corporation, the loss could only offset the company’s business income. It could not be claimed on your personal return. But owners of pass-through entities (e.g., partnerships and S corporations) and self-employed individuals often used an NOL to offset other income.

New law: Under the TCJA, the two-year carryback is repealed (except for qualified farms and insurance companies). So affecting NOLs can only be carried forward to future tax years, but they can be carried forward indefinitely.

In addition, the NOL deduction is limited to 80% of your taxable income (determined without regard to the NOL). These changes are effective for tax years beginning after 2017.

As a result, for a fiscal year that runs from

July 1, 2017, through June 30, 2018, you’re not subject to the 80% limit.

Finally, in a significant departure from prior law, another TCJA change restricts the ability of noncorporate taxpayers to deduct business losses. For 2018 through 2025, they can only deduct business losses up to $250,000 for single filers or $500,000 for joint filers against non-business income. Amounts above this threshold are considered “excess business losses” and must be included as part of your NOL carryforward to the following tax year. As explained, these NOL carryforwards will then be subject to the new 80% limit on NOL deductions.

The $250,000/$500,000 limit is applied at the partner or S corporation shareholder level after imposition of the passive loss rules. This can result in complex calculations.

Tip: Consult with your tax pro about NOLs.