COVID-19

New tax rules for deducting business losses

Due to difficult economic conditions, Congress has enacted the Coronavirus Aid Relief and Economic Security Act (CARES Act). Among many other things, this law makes it much easier for businesses to deduct losses. 

The CARES Act may enable you to get a refund on taxes you already paid in previous years. In some cases, you can get a refund on taxes as far back as 2013.

What’s an NOL, and who can claim it? 

A net operating loss—NOL for short—occurs when your annual tax deductions exceed your income. It usually happens when you own a business that loses money.

An NOL can also occur if you have substantial uninsured casualty losses—for example, an earthquake destroys your home.

If you’re like most self-employed people, you’re a sole proprietor. Namely, it means you personally own a business and its assets. You determine a business loss for the year by listing your business income and expenses on IRS Schedule C. If your costs exceed your income, you have a deductible business loss.

You deduct such a loss on Form 1040 against any other income you have, such as salary or investment income. If it exceeds your income, you have an NOL.

If you’ve formed a one-owner LLC, you ordinarily treat an NOL the same way. One-owner LLCs are usually taxed the same as sole proprietorships.

It also works in the same manner if you co-own a business organized as a partnership, limited liability company (LLC) or S corporation. Business losses pass through the business to the owners’ individual tax returns. However, you use IRS Schedule K-1 to report your losses.

If you’re the shareholder in a C corporation, the corporation deducts any losses, not the shareholders. They don’t directly benefit you.

Calculating an NOL

Calculating an NOL gets complicated. You don’t just subtract your business losses from your income. First, you figure your adjusted gross income on your tax return. Your AGI includes your business losses.

Then you deduct from your AGI your standard deduction or itemized deductions. You then need to add back:

  • Capital losses in excess of capital gains
  • Non-business deductions (including standard or itemized deductions) that exceed your nonbusiness income, and
  • The section 199A deduction for qualified business income

For details, see IRS Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.

Deducting an NOL Under the CARES Act 

The CARES Act allows you to use NOLs occurring during 2018, 2019, and 2020 to offset 100 percent of the income you earned during those years. Thus, if you have an NOL, you won’t have to pay any taxes for these years.

Not having to pay tax for a single year is nice. But the tax benefits of an NOL don’t end there. You can also deduct your NOL against taxes you paid in past years. This latitude will result in a quick tax refund from the IRS. An enormous help in times of economic stress.

The CARES Act allows you to carry back for five years NOLs incurred during 2018-2020. The law in effect before the CARES Act didn’t allow any carrybacks. So, this is a significant improvement for money-losing businesses. 

Ordinarily, you must carry an NOL back to the earliest year within the carryback period in which there is taxable income, then to the next earliest year, and so on. 

For example, if you have a 2020 NOL, you first carry it back to reduce taxable income for 2015. If the NOL is not used up, it is then applied to 2016, then 2017, and so on through 2019. Any amount left over gets carried forward to reduce taxable income in 2021 and any number of future years.

Deducting your NOL

Unfortunately, if 2020 turns out to be big money-losing year for your business, you’ll have to wait a while to benefit from your NOL.

Here’s the problem for 2020: You can only NOL after you’ve completed and filed your tax return for the year involved. The return will show the amount of the NOL. 

So, you won’t be able to take advantage of a 2020 NOL until the 2020 tax year ends and you file your 2020 tax return. At the earliest, this will the end of January 2021. The earliest you could get an IRS refund for a 2020 NOL will likely be April 2021.

However, if you have NOLs for 2018 or 2019, you can take advantage of them now. You should have already filed your 2018 tax return. If you have an NOL for 2019 and have not filed your return for the year, you should do so as soon as possible.

There are two ways to carry back an NOL and get a refund of prior years’ taxes. 

The best way is to file IRS Form 1045, Application for Tentative Refund. The IRS must process Form 1045 and send you your refund within 90 days. This is about is fast as the IRS ever does anything.

There is one tricky part to filing Form 1045. You ordinarily have to file it within one year after the end of the year you had the NOL.

So, you’ll have until December 31, 2021, to file Form 1045 for 2021 NOLs. You have until December 31, 2020, to submit Form 1045 for 2019 NOLs.

What about 2018 NOLs? Technically, you should have filed Form 1045 by December 31, 2019, which is impossible. IRS will have to extend this deadline—probably to the end of 2020.

The other way to claim an NOL is to amend your tax return for the year involved. To do this, file IRS Form 1040-X, Amended U.S. Individual Income Tax Return. You have three years after the end of the tax year to file Form 1040-X. But the IRS can take longer than 90 days to send you your refund when you file Form 1040-X.

It’s wise to seek help from a tax professional to calculate your NOL and complete Form 1045 or 1040-X. 

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Business Insights and Ideas does not constitute professional tax or financial advice. You should contact your own tax or financial professional to discuss your situation.