How to Manage a Net Operating Loss

If you completed your tax return and had more expenses than you did income, you may have what is known as a Net Operating Loss (NOL).

Both individuals and corporate (C-Corporation) taxpayers can have Net Operating Losses. The Federal Tax Code has special rules on what to do when you have an NOL and these rules recently changed with the passage of the CARES Act in March of this year.

Before, if you had a Net Operating Loss, you had to carry the loss to the following tax year and potentially reduce the amount of tax you owe. With the changes made by the CARES Act you can now carryback an NOL to a previous tax year. More specifically, a net operating loss incurred in tax year 2018, 2019 or 2020 can be carried back five years.

The benefit of an NOL carryback is rather than carrying your NOL forward, and reducing your next year’s tax liability, carrying it back means you can potentially reduce a prior tax liability. This also means you can claim a refund from the IRS much sooner than waiting until next year.

An NOL carryback can be especially beneficial if you are a C-Corporations as tax rates in tax years 2017 and prior were higher than what they are now.

To carryback an NOL, you use different forms than what you use for your annual tax returns. Individual taxpayers use Form 1045 and C-Corporations use Form 1139. If you want to use these carryback forms they must be filed by December 31^st of the year following the loss year. So, if you had an NOL on your 2019 income tax return, you would need to file a carryback form by December 31, 2020.

The IRS must process a carryback form within 90 days of receiving it.

If you miss the end-of-year deadline, you can still carryback an NOL—but you will need to file an amended return instead of using the carryback forms. The IRS does not have a deadline to process an amended return, so using a carryback form should grant you your refund much sooner.

Let’s walk through a quick example.

You just completed your 2019 income tax return and your business had more expenses than income in 2019 so your return shows a loss of $100,000.

You complete a carryback form to carry this Net Operating Loss back five years to your 2014 tax return which had taxable income of $250,000, by doing so you reduce your taxable income to $150,000.

You then recalculate your tax liability on this lower income; the difference between your newly recalculated lower tax amount and what you originally paid is what the IRS now owes you as a refund.

The above example was relatively straightforward, things can be a little more complicated if your NOL is greater than the taxable income you had five years earlier. Whether or not you can adjust your state income tax return for this NOL is another factor to consider.

To add one more item to consider, you are required to carryback an NOL but you can elect to waive these rules and carry your NOL forward if you choose. In some cases this may provide a better tax benefit.

The above example was relatively straightforward, things can be a little more complicated if your NOL is greater than the taxable income you had five years earlier. Whether or not you can adjust your state income tax return for this NOL is another factor to consider.

To add one more item to consider, you are required to carryback an NOL but you can elect to waive these rules and carry your NOL forward if you choose. In some cases this may provide a better tax benefit.