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Get a Tax Break From Past-Year Losses

A net operating loss (NOL) refers to a tax year in which a business’s allowable tax deductions exceed its taxable income. In simpler terms, you had more expenses than you actually had revenue. It’s not quite that simple when looking at what deductions the IRS allows to create a loss, but that’s the idea. U.S. Code IRC § 172 allows businesses to use that loss as a carryover toward future tax years or as a carryback to recoup money paid to the IRS in previous years. Calculating and taking advantage of an NOL can help you take advantage of a down cycle in your business.

Why does the NOL exist?

Given that businesses are taxed on the money they earn, the federal government determined that they deserve tax relief if they lose money.  Keep in mind that if you business continually has losses the IRS may consider it a hobby and disallow the losses.

If a business experiences a loss in a certain tax year, that loss may qualify as an NOL, and the company can apply that loss to previous tax years, going back more than five years. However, starting with the fifth year going back, you are able to receive only 50 percent of the taxable income for that carryback year as a deduction. Businesses also have the option of carrying forward their NOL as much as 20 years into the future.

How to calculate an NOL

There’s no sugarcoating it — calculating your NOL is time-consuming and often confusing. The rules for computing your NOL differ from the regular tax computation rules. For example, there are many deductions that you can take on a regular tax return that can’t be taken when calculating your NOL. Capital losses in excess of capital gains cannot be taken as part of a NOL carryback or carryforward for example, even if the capital loss came from selling business equipment.

If you decide to carry back an NOL, you are required to recalculate your adjusted gross income and any items such as IRA deductions or taxable Social Security benefits that were impacted by your original AGI. Furthermore, you’ll be required to recalculate your taxable income and your AMT, if applicable.

The net operating loss provides an opportunity for business owners, but it also can create a huge headache trying to follow all of the rules. Your accountant should no more about navigating the process to provide you with the best results.

 

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