Ever considered a scenario where your tax-deductible expenses exceed your taxable income? This situation, known as Net Operating Losses (NOLs), can be used to offset future taxable income, which can help you save on taxes. However, you must understand the laws that govern it, and learn how to effectively use NOLs as part of your tax strategy.
In this blog, we explore the basics of NOLs and what to consider when incorporating it into your financial plan.
Strategic Use of NOLs to Offset Future Taxable Income
The first step to using your NOLs is to track eligible expenses with precision. Expense management software can help you categorize tax-deductible expenses to facilitate accurate calculations.
To determine NOL eligibility, subtract your tax-deductible expenses from your taxable income. If the result is negative, you’ve incurred an NOL. In this case, you can carry forward the excess credit to offset profits in future years.
Recent Changes in Tax Law Regarding NOLs
Applying net operating losses to a previous year’s tax return is known as a tax carryback, while using them to offset future taxable income is called a carryforward. NOL tax laws have seen considerable revisions in recent years.
Before the Tax Cuts and Jobs Act (TCJA) of 2018, businesses could carry NOLs forward for up to 20 years and backward for up to two years. The introduction of the TCJA eliminated the two-year carryback option for most businesses, meaning you no longer enjoy an immediate refund when offsetting an NOL against previously paid taxes. However, the Act now offers an indefinite carryforward period, capped at 80% of taxable income for each subsequent year. If your business incurs NOLs over multiple years, you must utilize the losses in the order they were incurred before moving on to the next NOL. The Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily suspended the TCJA’s changes for the tax years 2018, 2019, and 2020, but the TCJA rules resumed for 2021 and beyond
Despite its changes, the new rules present both limitations and opportunities. NOLs still serve as a tax breather during tough financial circumstances, exempting you from paying tax for the period in question and allowing you to reduce your taxable income in profitable years as you carry forward available NOLs. Working with a CPA can help you optimize NOLs as part of your tax strategy.
Tax Planning Tips for Maximizing Savings with NOLs
Consider the following tips to maximize your tax savings with Net Operating Losses (NOLs).
1. Identify opportunities to generate NOLs
Make strategic business decisions that can lead to generating NOLs such as investing in new projects or embarking on significant tax-deductible expenses during lean years to create NOLs that can offset future taxable income.
2. Align business activities for optimal NOL use
Where possible time expenses and income strategically. Accelerate expenses or defer income to ensure that losses align with periods when they will be most beneficial.
3. Implement tax-efficient transactions
Structure transactions to generate NOLs while maintaining compliance with tax laws. For example, mergers or other business moves may result in NOLs for tax efficiency.
4. Ensure regulatory compliance
Familiarize yourself with the IRS rules and regulations that govern the utilization of NOLs and stay informed about any updates. It is also important to keep detailed records of income and expenses to support your NOL claims and IRS submissions.
5. Work with a tax professional
A CPA can incorporate NOL planning into your overall tax strategy. This helps ensure you utilize the benefit effectively and remain compliant with all relevant tax regulations.
At Fusion CPA, we have helped businesses across various states and industries develop a tax strategy that considers NOL as part of their long-term financial stability plan. From navigating expense tracking accuracy to ensuring accurate and timely submissions to the IRS, our CPAs can help you.
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This blog article is not intended to be the rendering of legal, accounting, tax advice, or other professional services. We base articles on current or proposed tax rules at the time of writing and do not update older posts for tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
