Net Operating Losses (NOLs)
 
Written by: Steven D. Beaucaire, MST
Director - Tax | Bedford Cost Segregation, LLC

The definition of a net operating loss (NOL) is the excess of expenses for the tax year over income for the tax year, which in some cases is subject to modifications. The NOL deduction under § 172 is available to a wide array of taxpayers. Taxpayers eligible to take advantage of the NOL deduction include individuals, C corporations, estates and trusts, and exempt organizations. In this article, NOLs will be discussed in general terms without going into all of their excruciating details.

All individual taxpayers are permitted to deduct net operating losses. NOLs of individuals are generally attributable to deductions and losses from a trade or business, deductible employee business expenses, or deductions for casualty or theft losses.

Most C corporations are allowed to deduct NOLs. While a corporation has fewer adjustments when calculating the NOL, because it is a separate entity, shareholders cannot deduct it. Extremely complicated rules exist to determine the allocation of NOLs between related parties, determining who can or cannot use them.

Because estates and trusts are considered taxpayers separate and apart from their beneficiaries, NOLs of decedents cannot be carried over and deducted by their estates. Similarly, NOLs sustained by estates and trusts are generally not deductible by the beneficiaries. An exception applies for unused net operating loss carryovers existing at the termination of an estate or trust, which may be deducted by the beneficiaries succeeding to the property of the estate or trust as provided in § 642(h).

Charitable organizations, social welfare organizations, labor organizations, agricultural organizations, business leagues, and numerous other categories of organizations are eligible for tax-exempt status. Despite their general tax exemption, exempt organizations are subject to the unrelated business income tax. This tax is on income not related to the exempt purpose of the organization. The net operating loss deduction is expressly allowed to exempt organizations in computing their unrelated business taxable income.

By definition a NOL cannot be used in the year it is generated so there exist rules to carryback or carryforward the losses. The general rule is that a NOL can be carried back two years and carried forward twenty. A taxpayer must carry the NOL back first unless he elects to carryforward only (§172(b)(3). Once you make this election, it is irrevocable. It is illustrated by way of this example as the order of carryback and carryover for 2008 net operating loss: T, a calendar year taxpayer, incurred a net operating loss of $50,000 in 2008. The two-year carryback period consists of the taxable years 2006 and 2007, and the 20-year carryover period consists of the taxable years 2009 through 2029 (§172(b)(1)(A). The earliest taxable year for which the 2008 NOL is allowable as a carryback or carryover is 2006. Thus, the NOL is first a carryback to 2006. If the NOL is not fully absorbed by 2006 taxable income, the unused part is a carryback to 2007. If the remaining loss is not fully absorbed by 2007 taxable income, the unused part is a carried over to 2009 and the succeeding years in the carryover period. If the NOL is not fully absorbed by 2029, the unused part cannot be deducted.

In the most recent “stimulus” bill, the 2008 NOL carryback period has been extended from two years to five years, but has been restricted to “small businesses”. The definition of small business for this purpose is restricted to those businesses with an average gross receipts less than or equal to $15,000,000. The taxpayer gets to pick the year to which the NOL is carried, any number above 2 and less than 6 is allowed. Thus, in the example above the earliest carryback year is 2003 not 2006. The IRS has issued Rev. Proc. 2009-19 to give guidance on how and when a taxpayer can elect the new NOL carryback. In these troubled times it gives one more reason to do a cost segregation study and that is to go back after those tax dollars you’ve already paid in to Uncle Sam.