By Edward A. Kollar, CPA, EA, CSEP
The Tax Cuts and Jobs Act (TCJA) of 2017 made major changes to IRC Section 172, Net Operating Loss (NOL) Deduction. An NOL is defined as, the amount of a taxpayer’s business deductions in excess of the taxpayer’s business income with certain modifications. 1
NOLs were first introduced with the Revenue Act of 1918. The act created NOL relief for the losses suffered by businesses during World War I. The initial carryback and carryforward periods were both one year. The justification for implementing the NOL was to offset the timing consequences of the annual tax accounting period. NOLs make it possible for entities with fluctuating income to receive equitable tax treatment when compared with entities that have more stable year to year income.
Throughout the history of the federal income tax there have been many NOL changes. Eliminating the carryback provision and leaving only a two-year carryover provision occurred in the 1920s. The NOL carryover was eliminated with the National Recovery Act of 1933, which was enacted during the Great Depression. A two-year carryback and carryforward came into effect during World War II, allowing businesses to deduct wartime losses against prewar profits. The NOL carryover period was extended to five years during the 1950s to stimulate business growth, with the carryback period initially decreasing to one year. The carryback provision was later increased to two years, and eventually, by 1958, settled at three years.
The Tax Reform Act of 1976 brought about the election to relinquish the carryback period and only carry forward the loss. The carryforward period was extended to 15 years with the 1981 Economic Recovery Act. The Tax Relief Act of 1997 brought about another change: a two-year carryback and a 20-year carryforward. The economic stimulus needed after the Sept. 11, 2001, terrorist attacks precipitated a temporary five-year carryback extension period, and during the period of the Great Recession of 2009 a carryback election was available of three, four, or five years.
The current changes to IRC Section 172 brought about by the TCJA generally allow for an indefinite carryforward period, but the TCJA eliminates the provision that allowed losses to be carried back. This change is applicable for losses arising in tax years beginning after Dec. 31, 2017. However, there are specific rules that apply to farming losses and to casualty and property insurance company losses2 not discussed here.
IRC Section 172 was also amended to limit the carryover amount to the lesser of the aggregate of NOL carryovers to the taxable year or 80 percent of the taxable income without regard to the NOL deduction. The effect of this change necessitates planning for potential tax payments. If a taxpayer was forecasting that his prior year’s losses would be large enough to entirely offset the current year’s income, the 80 percent taxable income limitation, as provided by the TCJA, would prove that forecast incorrect. This limitation basically has the effect of reducing the value of the NOL – the NOL can no longer completely offset 100 percent of the tax year’s taxable income.
NOLs from taxable years beginning before Jan. 1, 2018 (pre-2018 carryovers), are subject to the prior law of 100 percent deductibility and a 20-year carryover period. This may necessitate taxpayers having both pre-2018 carryovers and post-2017 carryovers.
Taxpayers in this situation would use the pre-2018 carryovers first, without any limitation. After that, the 80 percent of taxable-income limitation would apply. The Joint Committee of Taxation provides an example3 of taxpayers with both pre-2018 and post-2017 carryovers.
Adding to the difficulty of IRC Section 172 is the new individual “excess business loss” limitation.4 Excess business losses are not allowed for tax years after Dec. 31, 2017; however, those disallowed losses, in the following years, are treated as NOLs.
Excess business losses are calculated as the taxpayer’s trade or business deductions over the sum of the gross income from the businesses, plus $250,000 (or $500,000 for a joint return); thereby creating a business loss limitation.
As you can see, the treatment of NOLs has continually changed throughout the years, keeping CPAs and their clients on their toes…and very busy.
1 IRC Section 172(c); Reg. Section 1.172-1
2 IRC Section 172(b)(1)(B) and Section 172(b)(1)(C)
3 JCT Blue Books, JCT General Explanation of Public Law 115-97, JCS-1-18 (Congress)
4 IRC Section 461(l)
Edward A. Kollar, CPA, EA, CSEP, is firm director for Baker Tilly Virchow Krause LLP in Wilkes-Barre and a member of PICPA’s Federal Tax Committee. He can be reached at firstname.lastname@example.org.
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