Okay, you’re not in business to lose money but it can happen from time to time. The tax law has new rules in store for you when it comes to writing off business losses in 2018 and beyond. These rules make it more difficult to use losses to save taxes.
Net operating loss
Essentially, a net operating loss arises when the amount of a current business loss is greater that what can be used in the current year (i.e., greater than taxable income), it becomes a net operating loss (NOL). (Technical rules apply to make an NOL more complicated than this.)
When and how the NOL is used has been changed by the Tax Cuts and Jobs Act.
- NOLs arising prior to 2018. Generally these NOLs can be carried back for 2 years (there are some special rules for certain situations and an option to waive the carryback) and forward for up to 20 years. The NOLs can offset up to 100% of taxable income.
- NOLs arising in 2018 and beyond. No carryback is allowed (other than for certain farming losses and losses of property and casualty insurance companies), but there’s an unlimited carryforward. However, the NOL can only offset up to 80% of taxable income.
Recordkeeping. If you have a carryforward of a pre-2018 NOL, be sure to keep track of it separately from newer ones so you can use it as a 100% offset going forward. NOLs are taken into account in the order in which they are generated, so that old NOLs are used before newer ones. This rule hasn’t changed.
Noncorporate excess business losses
If you own a pass-through entity—sole proprietorship, partnership, S corporation, or limited liability company—the rules for writing off your losses have changed dramatically. Until now, if you had $1 million in revenue and $1.6 million in expenses, the $600,000 loss passed through to you would be deductible on your return (limited by your basis in the business).
Now there’s an important change in the treatment of losses. Instead of being currently deductible, excess business losses are characterized as net operating losses that must be carried forward.
What is a noncorporate excess business loss? This is the excess of business deductions for the year over the sum of (1) gross income or gain from the business, plus (2) $250,000 for singles or $500,000 for joint filers (with these dollar amounts adjusted for inflation after 2018).
So continuing the example I started earlier, under the new loss limit, instead deducting $600,000 in 2018, assuming you’re single, you’d only be able to write off $350,000 ($1.6 million – [$1 million + $250,000]). The balance of the loss--$250,000—is treated as a net operating loss that becomes deductible in 2019 to the extent permissible (explained earlier).
For owners of partnerships and S corporations, the limit is applied at the owner level, based on the owner’s distributive share of business income and expenses.
The excess business loss limit applies after applying the passive activity loss limit. The excess business loss limit is effective from 2018 through 2025.
To sum it up, when you’re doing well, the government is your partner by sharing in your good fortune via taxes. But when you aren’t doing well, the government doesn’t want to know you anymore. The Tax Cuts and Jobs Act rewards profitable businesses by lowering the taxes to be paid on profits. But this same law essentially penalizes unprofitable businesses by imposing limits on utilizing losses. In the past, for example, if you had an NOL, you could carry it back to generate an immediate cash refund that could be ploughed into the business. In effect, a loss could be turned into a gain. No longer.
Perhaps the lesson here is: Be profitable. Take the steps you need to ensure this—cut expenses, raise prices, etc. And work with your tax advisor to see what other measures can be used to keep you in the black.