Utilizing NOLs and Capital Loss Limitations

Posted on June 4, 2024

NOLs

Net Operating Losses - The result when a company's allowable deductions exceed its taxable income within a tax period. If your business operates and looses money, then that net operating loss can be carried back for a TAX REFUND, by applying it to the taxes paid in earlier years. But if for some reason, you are not able to carry back the net operating business losses (maybe because you did not pay any taxes in earlier years) you can still carry them forward and REDUCE TAX LIABILITY in future years by applying the NOLs to the years when there is positive taxable income.

NOL Carryback and Carryforward Rules

C Corporations are entitled to the same net operating loss (NOL) rules as individuals :

1. NOL Rule prior to 2018 (2017 and prior years)

• NOLs can be carried back 2 years and carried forward 20 years
• NOl carryforwards can offset 100% of future taxable income

2. For 2018, 2019, 2020, NOL Rule was modifed

• For 2018, 2019 and 2020, NOLs can be carried back 5 years and could be carried forward forever
• NOLs carry forward can offset-
• 100% of taxable income for 2018, 2019 and 2020
• 80% of taxable income for 2021 & future years after deducting pre-2018 NOL carryforward

3. NOL Rule for 2021 and into the future

• NOLs cannot be carried back but can be carried forward forever
• We can offset only 80% of taxable income for 2021 & future years after deducting pre-2018 NOL carryforwards

Net Operating Loss Calculation

• No charitable contribution deduction is allowed in calculating the NOL
• The NOL deduction for an NOL carryover from a prior year is not allowed in determining a current year NOL- in other words, the prior year NOL cannot be used to create or increase the current year NOL

Limitations on NOL Carryforwards Following an Ownership Change

• When a ownership change occurs with respect to an acquired corporation, operating at a loss, (termed as "loss corporations" per IRC Section 382), the amount of taxable income that may be offset with the NOL of the loss corporation, arising from the ownership change is limited
• Section 382 has been enacted by the Congress to prevent a corporation with a large amount of taxable income from:
• purchasing a company with NOL carryforwards, and
• using those acquired NOLs to offset income

Section 382 Ownership Change

• The Section 382 loss limitations are triggered by an ownership change - but how much ownership change ??
• An ownership change under Section 382 occurs:
• when there is one or more 5 percent shareholder and
• those shareholders increase their aggregate ownership of the loss corporation's stock during the testing period

Important Definitions

"5 percent shareholder"

• A "5 percent shareholder" for the purposes of this test is any shareholder who owns 5 percent or more of the loss corporation's stock at any time during the testing period.

"Testing Period"

• The testing period is typically the three-year period ending on, but also including, the date of the change in ownership.

Section 382 Loss Limitation -- How do we calculate it ??

• The annual Section 382 loss limitation is equal to the fair market value (FMV) of the loss corporation's stock immediately before the ownership change multiplied by the federal long-term, tax-exempt rate ( which is published periodically in the Internal Revenue Bulletin).
• If the limitation amount is greater than the taxable income amount for the year, any unused Section 382 limitation -
• is carried forward, and
• increases the next year's limitation amount

Capital Losses

Individual Net Capital Loss :

If you are an individual you can offset $3,000 maximum in any given year against any income even ordinary income.

• Carryback - As an individual, you cannot carry back any capital losses to get a refund.
• Carryforward - Individuals can carry forward any capital losses for an indefinite period in the future.

Corporate Net Capital Loss :

A corporation can only use capital losses to offset capital gains. Capital loss carryover will always be carried over as short-term capital losses and they are applied only against capital gains.

• Carryback - Corporations can carryback the net capital losses for three years to offset the capital gains in those years and get a refund.
• Carryforward - Capital losses can be carried forward five years to offset capital gains in those years and thus reduce the tax liability.