Net Operating Losses of Individual Taxpayers

Net Operating Losses of Individual Taxpayers

As per your requests for general information on the deductibility of an individual's net operating losses (NOLs).

Generally, if your deductions for the year are more than your income for the year, you may have an NOL, which you can use by deducting it from your income in another year or years. For individuals, losses from operating a business are typically the most common reason for an NOL. Although partnerships and S corporations generally cannot use an NOL, partners or shareholders can use their separate shares of the partnership's or S corporation's business income and deductions to figure their individual NOLs.

Some items are not allowed when computing an NOL, including: (1) capital losses in excess of capital gains, (2) the exclusion of the gain from the sale or exchange of qualified small business stock, (3) nonbusiness deductions in excess of nonbusiness income, (4) the NOL deduction (meaning that any deductions taken for NOL carrybacks or carryforwards from other years must be added back in determining the amount of the NOL for the current year), and (5) the deduction for qualified business income.

Some important changes to the NOL rules came about as a result of recent tax legislation. Under the Tax Cuts and Jobs Act (TCJA), enacted in 2017, the amount allowed as an NOL in tax years beginning after 2017 could not exceed 80 percent of the taxpayer's taxable income, computed without the NOL deduction. In addition, TCJA eliminated the option to carry back an NOL to earlier tax years for NOLs arising in tax years beginning after 2017. However, these rules were temporarily suspended as a result of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted in 2020. Under the more favorable rules, the 80-percent income limitation does not apply to NOLs arising in tax years 2018, 2019, and 2020. In addition, a five-year carryback period applies for NOLs arising in these years, although you can elect to waive this carryback period and instead carry forward your NOLs arising in 2018, 2019, and 2020.

In the case of a tax year beginning after 2020, your NOL is equal to the sum of:

(1) the aggregate amount of NOLs arising in tax years beginning before January 1, 2018, carried to such tax year, plus

(2) the lesser of (i) the aggregate amount of NOLs arising in tax years beginning after December 31, 2017, carried to such tax year, or (ii) 80 percent of the excess (if any) of taxable income computed without regard to certain deductions over the amount determined in (1).

Additionally, the TCJA enacted an excess business loss limitation rule which was also substantially modified as a result of the CARES Act. As originally enacted, the excess business loss limitation rule provided that, for tax years beginning after 2017 and before 2026, excess business losses (i.e., the excess of aggregate deductions attributable to your trade or business over the sum of your aggregate gross income or gain, plus an inflation-indexed threshold amount ($259,000 for 2020)) were disallowed and had to be carried forward and treated as part of your NOL carryforward for subsequent tax years. However, the CARES Act temporarily suspended this rule so that excess business losses are allowed for tax years 2018, 2019, and 2020. The excess business loss limitation was further modified under the American Rescue Plan Act, enacted in 2021, to extend the limitation through 2026 (rather than 2025 as originally provided in the TCJA).

As you can see, the revised rules for NOLs incurred in 2018, 2019, and 2020 are quite favorable and it is important to make sure we take full advantage of these changes. Please call me at your convenience so that we can examine how the NOL rules apply to your particular situation and whether you have a refund coming your way.

Be well and stay safe.

If you Have Question About Your Tax Situation Please Call ETS @ (469) 262-6525

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