Net Operating Losses
March 29, 2021
Generally, a net operating loss (NOL) is an excess of deductions (for expenses from the operation of a business) over income from the operation of a business. For individuals, an NOL may also be attributable to casualty losses.
NOLs arising in tax years beginning in 2018, 2019, and 2020 may be carried back for a period of five years and carried forward indefinitely. A taxpayer may elect to forego the carryback. Generally, an NOL arising in a tax year beginning in 2021 or later may not be carried back and instead must be carried forward indefinitely. However, farming losses arising in tax years beginning in 2021 or later may be carried back two years and carried forward indefinitely. NOLs of non-life insurance companies arising during these years may also be carried back two years and carried forward 20 years.
What amount is deductible as a net operating loss (NOL)?
Generally, for a tax year beginning in 2018 or later, a net operating loss (NOL) deduction for any tax year equals the lesser of:
- the aggregate of the net operating loss carryovers to such year, plus the net operating loss carrybacks to such year; or
- 80% (or 100% for NOLs generated in tax years beginning before 2021) of taxable income computed without regard to the allowable NOL deduction
The 80% limitation applies to REIT NOLs, but it does not apply to losses of non-life insurance companies.
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Which taxpayers are allowed to deduct net operating losses?
- C corporations
- estates and trusts
- exempt organizations
- insurance companies
- personal holding companies, under certain circumstances
- S corporations
- regulated investment companies
- corporations subject to the accumulated earnings tax
- cooperative organizations
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How is net operating loss calculated?
An individual’s net operating loss is equal to the taxpayer’s deductions less gross income, modified as follows:
- the NOL deduction is disallowed for an NOL carryback or carryover from another tax year
- the deduction of business and nonbusiness capital losses is limited to the amount of capital gains
- the deduction of nonbusiness deductions is limited to the amount of nonbusiness income
- the exclusion for capital gains from small business stock under IRC §1202 is not allowed
- the deduction for qualified business income is disallowed
A corporation’s net operating loss (NOL) is equal to the corporation’s deductions less gross income, modified as follows:
- the NOL deduction is disallowed for an NOL carryback or carryover from another tax year;
- the dividends-received deductions under IRC §243 and IRC §245 are computed without regard to the aggregate limitations that normally limit these deductions; and
- the deduction for foreign-derived intangible income is disallowed
Bloomberg Tax & Accounting surveyed tax professionals at public and private corporations with at least $500 million in annual revenue to explore the impact that Covid-19 has had and continues to have on corporate tax departments.
How did the CARES Act affect NOLs for corporations?
Prior to the CARES Act, NOLs arising in years after 2017 were not allowed to carry back, had an unlimited carryforward period, and were limited to 80% of taxable income. The CARES Act retroactively modified and expanded those rules. Under the CARES Act, NOLs arising in years beginning 2018 through 2020 may be carried back five years and the 80% NOL deduction limit is temporarily lifted for NOL carryforwards to years beginning before January 1, 2021.
Under a long-standing provision, IRC §172(b)(3), a corporation can elect to waive this five-year carryback. A corporation making an election under section 172(b)(3) can still take advantage of the temporary changes to the 80% limitation rules and offset 100% of taxable income with NOL carryforwards that would otherwise be subject to the limitation.
There are complicated interactions with other rules, particularly for multinational corporations. Those corporations that repatriated income under IRC §965 between 2016 and 2019 may not offset inclusion income under a deemed election under IRC §965(n). However, CARES provides for an election to skip IRC §965 years while still applying the NOL carryback to other years.
The impact on other tax attributes needs to be carefully considered as well. For example, general business credits (GBCs) and foreign tax credits (FTCs) may be freed up by the NOL carryback and may now carry back or forward to other years. The alternative minimum tax (AMT) may also come into play, not only with a minimum tax but with the limitation for general business credits as well.
The separate return year rules come back into play with consolidated return groups. NOLs may need to be allocated to a departing consolidated return member.
These new rules provide many planning opportunities to provide an infusion of cash to cash-strapped businesses, but it is critical to evaluate all the possible scenarios to avoid any unintended negative consequences.
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This webinar provides a more complete picture of the impact of the CARES Act on NOLs, the potential consequences of relaxing two NOL rules, and how these changes influence tax planning.
Did the Covid-Related Tax Relief Act further impact NOLs?
The Covid-Related Tax Relief Act allows farmers who elected a two-year NOL carryback before the CARES Act to elect to retain that two-year carryback rather than claim the five-year carryback provided in the CARES Act. It also allows farmers who previously waived an election to carry back an NOL to revoke the waiver. This provision applies retroactively as if included in the CARES Act.
The CARES Act contains changes to NOLs, business interest expense deductions, and refundable minimum tax credit (MTC), which give rise to a significant carryback claim opportunity.
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