Business losses can occur for a variety of reasons. They could be the result of financial challenges, but losses can also happen when you take chances, expand, or grow in ways that are necessary to trigger more success.
Whatever the reason for your business losses, do not overlook opportunities to use those losses to offset taxes. This can be done in the tax year in which the losses occurred, but you can also carry forward excess losses to offset taxes for years to come.
Both corporations and pass-through entities (including individuals, LLCs, S corporations, and partnerships) can offset business income with losses, but the rules and allowances differ and have changed in key areas in recent years. The changes, like many others, arose from the Tax Cuts and Jobs Act (TCJA) of 2017, although the Coronavirus Aid, Relief, and Economic Security (CARES) Act suspended some until 2021.
As the IRS summarizes here, most taxpayers:
- No longer have the option to carry back an NOL. With few exceptions, including for some farming losses and for insurance companies outside of life insurance, NOLs occurring in 2021 and onward can only be carried forward.
- Are now limited to 80% of the excess loss against taxable income for each year it’s carried forward.
- Are subject to loss limitations if they are noncorporate taxpayers. These thresholds were set in 2021 and adjusted for inflation. The limit for 2024, for instance, is $305,000 ($610,000 for married couples who file jointly).
Quite simply, if your deductions for the year are more than your income for the year, you have an NOL. You can keep using that NOL to reduce future year taxes until it is “used up,” subject to the limitations stated above. As with most other tax opportunities, however, what appears straightforward is not. Calculating NOLs can be complicated as can balancing them with other tax deductions.
Consider the following:
- Your business ownership. The IRS states that partnerships and S corporations generally cannot use an NOL. However, their shares of the business income and deductions can be used to determine individual NOLs. At-risk and passive activity limits must also be applied before calculating the amount of any excess business loss.
- How you’re calculating the losses. The IRS includes a laundry list of allowed and unallowed items to consider when calculating losses, as well as a worksheet to help figure it all out. These “helpful” guides can be mind-numbing. They include factors like adjusted gross income (AGI) and nonbusiness capital losses, which require their own worksheets to determine.
- Other businesses that could affect the bottom line. For pass-throughs, excess business loss is calculated against all of a taxpayer’s trade or business gross income and gains. These include all Schedule F, Schedule C, other business activities reported on Schedule E, as well as business gains and losses reported on Form 4797.
- Other deductions to consider. The true art of utilizing NOLs for tax savings is in balancing the opportunity with other deductions. Start by asking yourself how the losses were incurred. Were capital expenses, including equipment or property, a factor? What about activities that could be categorized as research and development (R&D)? These losses may be offset in other ways, allowing you to stretch an NOL opportunity even further.
As you can see, navigating the complexities of NOLs can be daunting, but the potential tax benefits make it worthwhile. Utilizing NOLs effectively can provide significant relief and support your business’s financial health as you navigate through periods of loss and growth.
Whether running a corporation or a pass-through entity, business owners must carefully assess their business structure and other factors that could affect the NOL. Engaging with a tax professional can help maximize the benefits of NOLs while ensuring compliance with current tax laws. Feel free to contact us with questions.
