Tax Benefits of Net Operating Losses

A net operating loss, or NOL, occurs when a business’s operating expenses and other deductions for the year exceed its revenues. Although the name would seem to indicate that operating in a “loss” situation is negative, there may be tax benefits of net operating losses: a tax deduction.

Understanding the Rules

To qualify for an NOL deduction, you must have business expenses in excess of your business income, though certain modifications apply. Generally speaking, once you incur a qualifying NOL, you can either carry back the NOL as far as allowable (typically two years) and then carry forward any remaining amount, or you can elect to carry forward the entire loss. Carrying back a loss can generate a current tax refund, which could free up cash flow during difficult times like these. Carrying forward a loss will offset income for up to 20 years in the future.

A Review of How it Works

To illustrate the NOL concept, let’s look at a fictitious example:

Having suffered a drastic slowdown in sales, Company X, a C corporation, shows a $60,000 NOL for the 2013 tax year.

According to the rules, Company X can choose a carryback period for its NOL of two years preceding the loss (first to the earliest year) and then carry forward any remaining amount for up to 20 years after the year in which it incurred the loss. So, Company X could elect to carry back the entire loss first to 2011. If its 2011 net income was $6,000, it could use $6,000 of the NOL to offset this income and receive a refund of the tax it previously paid on that income.

Then Company X would have $54,000 of remaining NOL to apply to the 2012 tax year, after which it would have whatever it hadn’t used in 2012 to carry forward to 2014 and beyond until it exhausted the entire $60,000 loss or hit the 20-year mark, whichever occurred first.

Another Scenario

On the other hand, Company X could opt to carry forward the full amount of its $60,000 NOL. In this case, the business could take up to 20 years to use it as long as the NOL was used to offset any net income each succeeding year. This could help reduce Company X’s income in years when it might be in a higher tax bracket.

Going back to that $60,000 NOL, using it to offset income in a 35 percent bracket year could save the business $21,000, while the same loss that offsets income in a 15 percent bracket year would save only $9,000 — a $12,000 difference.

Thus, if the company reported low income in the previous two years and consequently fell into low tax brackets, it might want to save the NOL for a carryforward to subsequent years — particularly if future projections appear brighter. Company X may also want to opt for a carryforward if its alternative minimum tax (AMT) liability in previous years makes the carryback less beneficial.

NOLs to the rescue

If your business needs a shot of cash, carrying back an NOL might be just what the doctor ordered. On the other hand, carrying the entire loss forward might be more beneficial for your business’s long-term health. To get a better grip on which prescription is right for you, consult your tax advisor or contact GTM.

This information is for general guidance only, and does not constitute legal advice, tax advice, accounting services, investment advice, or professional consulting. The information should not and may not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making decisions or taking actions, consult a professional adviser who has been provided with all pertinent facts relevant in your particular situation. Tax articles are not intended to be used, and cannot be used, for the purpose of avoiding accuracy-related penalties that may be imposed on a taxpayer.