One of the less publicized effects of the new tax law or TCJA (Tax Cuts and Jobs Act law) that passed late last year is the impact on net operating losses. The full effect of the changes won’t be felt until 2019 because only NOLs generated after 12-31-17 are subject to the new guidelines. Traditionally, any taxable losses generated in one year could be carried forward to fully shield any taxable income generated in subsequent years. The initial losses could be carried forward up 20 years (and optionally back two years) until such losses were fully absorbed. Under the pre-TCJA law, an NOL wasn’t subject to any limitation based on taxable income. Currently, the TCJA limits the NOL deduction to 80% of taxable income, determined without regard to the NOL deduction itself. Accordingly, any NOLs generated after 12-31-17 will only cover up to 80% of taxable income beginning in 2019.
For example – In 2018, an individual taxpayer generates a $90,000 NOL. They have no other NOL carryovers and carries forward the NOL to 2019, a year which has taxable income of $100,000. The taxpayer’s 2019 NOL deduction is limited to $80,000 ($100,000 x 80%). The remaining $10,000 can’t be deducted in 2019, but can be carried forward indefinitely.
If you’re thinking that your current year (2018) NOL will result in a cash infusion via carry-back to more profitable years in 2016 and 2017 – think again. As a means to raise additional revenue to pay for new tax law – Congress has eliminated the NOL carryback provisions that provided a silver lining to any tax year generating substantial tax losses. Under the old law, a significant taxable loss could be carried back up to two years to absorb taxable income for those years. The two-year carryback provided a way for profitable businesses that had suffered a down year to receive a much-needed cash infusion, particularly when the taxpayer applied for a quick carryback refund. In the past- the taxpayer could forgo the carryback and elect to carryforward the entire NOL up to 20 years. The new tax law does away with the 20 year requirement and allows a post 12/31/17 generated NOL to be carried forward indefinitely.
The practical effect of this change to NOLs is that pre-2018 generated losses will need to be separately tracked. For any years with taxable income, there will still be some taxable income generated regardless of the size of any NOL’s carried forward from prior years. There are special carve-out exemptions for both insurance and farming businesses. For everyone else, losses generated in current years will have less value when taken in future years.
As far as California goes – nobody knows. The state has not introduced any pending legislation to amend the way in which CA NOLs are treated. But NOLs aren’t a top tier issue for CA at this time as other portions of the TCJA (most notably the $10,000 limitation on state and local taxes) have been getting much greater attention. Other issues such as the $750,000 cap on mortgage interest deductions have crowded the discussion as well. This makes sense given that the NOL question wouldn’t have any effect until after the 2018 tax year returns have been filed. The fact that CA currently has a healthy budget surplus may also have some effect on the legislative mood in Sacramento. At some point, however, CA will need to figure which way to go on this issue.
Do you have more questions in regards to net operating losses and the Tax Cuts and Jobs Act? Give our office a call today, 562-420-3100.
By: Evan Sandler, CPA, MST
Tax Manager Onisko & Scholz, Certified Public Accountants TCJA impact on NOLs
One of the less publicized effects of the new tax law or TCJA (Tax Cuts and Jobs Act law) that passed late last year is the impact on net operating losses. The full effect of the changes won’t be felt until 2019 because only NOLs generated after 12-31-17 are subject to the new guidelines. Traditionally, any taxable losses generated in one year could be carried forward to fully shield any taxable income generated in subsequent years. The initial losses could be carried forward up 20 years (and optionally back two years) until such losses were fully absorbed. Under the pre-TCJA law, an NOL wasn’t subject to any limitation based on taxable income. Currently, the TCJA limits the NOL deduction to 80% of taxable income, determined without regard to the NOL deduction itself. Accordingly, any NOLs generated after 12-31-17 will only cover up to 80% of taxable income beginning in 2019.
For example – In 2018, an individual taxpayer generates a $90,000 NOL. They have no other NOL carryovers and carries forward the NOL to 2019, a year which has taxable income of $100,000. The taxpayer’s 2019 NOL deduction is limited to $80,000 ($100,000 x 80%). The remaining $10,000 can’t be deducted in 2019, but can be carried forward indefinitely.
If you’re thinking that your current year (2018) NOL will result in a cash infusion via carry-back to more profitable years in 2016 and 2017 – think again. As a means to raise additional revenue to pay for new tax law – Congress has eliminated the NOL carryback provisions that provided a silver lining to any tax year generating substantial tax losses. Under the old law, a significant taxable loss could be carried back up to two years to absorb taxable income for those years. The two-year carryback provided a way for profitable businesses that had suffered a down year to receive a much-needed cash infusion, particularly when the taxpayer applied for a quick carryback refund. In the past- the taxpayer could forgo the carryback and elect to carryforward the entire NOL up to 20 years. The new tax law does away with the 20 year requirement and allows a post 12/31/17 generated NOL to be carried forward indefinitely.
The practical effect of this change to NOLs is that pre-2018 generated losses will need to be separately tracked. For any years with taxable income, there will still be some taxable income generated regardless of the size of any NOL’s carried forward from prior years. There are special carve-out exemptions for both insurance and farming businesses. For everyone else, losses generated in current years will have less value when taken in future years.
As far as California goes – nobody knows. The state has not introduced any pending legislation to amend the way in which CA NOLs are treated. But NOLs aren’t a top tier issue for CA at this time as other portions of the TCJA (most notably the $10,000 limitation on state and local taxes) have been getting much greater attention. Other issues such as the $750,000 cap on mortgage interest deductions have crowded the discussion as well. This makes sense given that the NOL question wouldn’t have any effect until after the 2018 tax year returns have been filed. The fact that CA currently has a healthy budget surplus may also have some effect on the legislative mood in Sacramento. At some point, however, CA will need to figure which way to go on this issue.
Do you have more questions in regards to net operating losses and the Tax Cuts and Jobs Act? Give our office a call today, 562-420-3100.
By: Evan Sandler, CPA, MST
Tax Manager Onisko & Scholz, Certified Public Accountants