Tax ARTICLE - The Net Operating Loss Deduction
A Tax Break for Tough Times

Target Audience: Business Owners, Entrepreneurs, Start-up Companies, Financial Managers, Accounting Consulting Firm Advisement Interest, Tax New and Business Updates, Tax Hints and Tips Interest, Companies Effected by Economic Hardship, Tax Deductions Interest

For much of the year, fears of an economic downturn — voiced in everything from gloomy whispers to screams of outright panic — have permeated the news. Whether or not tough times lead to your company losing money, one way to mitigate any shortfall may be to claim a tax deduction for a net operating loss (NOL).

3 Elections to Consider

Formally defined, a net operating loss occurs when a corporation’s or individual’s deductible expenses exceed income for a tax period.

If your business is organized to operate as a C corporation, the net operating loss occurs at that level. Similar rules apply at the individual level if your business is a flow-through entity. But, in that case, your business loss will need to be large enough to also offset your income from other sources, such as salary or investment income.

You may deduct an NOL from your taxable income in three ways:

1. You can claim a deduction in previous years (called a “carryback claim”), which creates a refund of taxes paid in prior years.
2. You can elect to forgo the carryback and claim a deduction in future years (called a “carryforward”), which lowers your future tax liability.
3. You can claim both a carryback and carryforward, though you must first carry back losses to the earliest tax year for which you qualify, after which you may carry forward any remaining losses.

The term “carryback period” refers to how far back you may apply a loss. Generally, business owners can carry back NOLs for two years before the year of the loss, which is often referred to as the NOL year. (As this issue went to press, Congress was considering a temporary extension of the NOL carryback period. Check with your CPA for the latest info.) You can carry forward a loss up to 20 years into the future.

There are also special carryback periods for casualty losses and certain farming losses, disaster-related losses and “specified liability” losses. If you think one of these might apply to your business, ask your CPA for further details.

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NOLs in Action

Let’s look at an example. XYZ Widgets Inc., a C corporation, suffered an NOL in 2007. It can benefit by applying its losses against income in 2005 and 2006 and receiving a refund of taxes paid in those prior years from the IRS to boost its cash flow.

If, instead, the business is already doing better by the time it is filing its tax return and expects substantial profits this year, its increased income could put it in a higher tax bracket than in previous years. Thus, the company’s owners may want to waive the carryback period and carry forward the NOLs to later years, when it’s being taxed at a higher rate.

The AMT Effect

Although most people associate the alternative minimum tax (AMT) with individuals, it applies to businesses as well. In short, the AMT is an alternative tax system that calculates tax liability differently. You must pay the AMT if your AMT liability is greater than your regular tax liability. The question is: Can you offset AMT income with NOLs, or are these losses reserved for regular tax purposes?

This question raises a number of interesting points. For starters, yes, you can deduct NOLs from your AMT income under similar rules as for regular income tax purposes. But, remember, if you opt to forgo a carryback period for regular tax purposes, you’ve automatically done so for AMT purposes as well.

Conversely, if you intended to use a carryback period for regular tax purposes, you must also use it for the AMT. Note that your AMT loss, and therefore the AMT NOL, may be different from the regular tax NOL. Look carefully at the total impact on your tax.

Not Entirely Merciless

The NOL rules offer some measure of respite from the foibles of the economy, unfortunate business mistakes and plain old bad luck. Those rules are, however, complex, so be sure to enlist your tax advisor’s help in planning for and claiming any NOL deduction.

Stimulus Package Boosts ’08 Asset Acquisition Deductions

So maybe all of the recent economic uncertainties haven’t hurt your business, and you’re in the market for some new equipment. Or maybe they have, but you still need to buy some new equipment to stay competitive. In either situation, the federal government has given you a pretty good reason to make the acquisitions.

As you may have heard, to spur additional investment, the president signed the Economic Stimulus Act of 2008 earlier this year. The act increases the Section 179 limit for initial year expensing to $250,000 (from $128,000).

The Sec. 179 expensing election allows a current deduction for newly acquired assets that you’d otherwise have to depreciate over a number of years. Because this tax break is designed to benefit primarily smaller businesses, it begins to phase out dollar for dollar when total asset acquisitions for the tax year exceed $800,000 (up from $510,000 before the act).

The new higher limits apply only for calendar year 2008 or a business’s fiscal year that begins in 2008. You can claim the expensing election currently only to offset net income from the business, not to create a taxable loss.

Another depreciation-related provision offers a special allowance for certain property, generally only if acquired and put into service in 2008. This is in addition to any such property that qualifies for Sec. 179 expensing. For eligible property, the special “bonus” depreciation amount is equal to 50% of its adjusted basis. Types of property that may qualify include tangible property with a recovery period of 20 years or less, computer software, water utility property, and qualified leasehold improvement property.

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