There has for sure been a lot of talk about tax returns lately and how someone can have a huge loss and then not pay taxes for a while…. Well, it really isn’t a big secret. I would hope that any first year tax preparer would know this.
The rule that will let you right off income from taxation dates back to 1918 (I Think), U.S. Title 26 U.S. Code § 172 – Net operating loss deduction.
It was enacted to prevent businesses from being penalized by the administrative convenience of calendar-year taxation.
If a company loses $50,000 one year, and makes $50,000 the next year, the law allows a company to pay nothing in taxes, because it has only broken even.
Be aware, there are a lot of other factors involved, depending on the company formation. Things like If the company is a flow through entity or not, along with other factors.
- Publication 536
- 26 U.S. Code § 172 – Net operating loss deduction
- 26 U.S. Code § 382 – Limitation on net operating loss carryforwards
There are many more references out there. But I feel like that should be enough for the real research taxpayer curious how to use this rule. It is strongly suggested that if you are able to use this, that you have a qualified tax preparer guide you all the way.
If a taxpayer has a negative amount for their Income before exemptions, he or she may have an NOL. If the amount on that line is positive, the taxpayer does not have an NOL.
Now, This calculation must be taken further, since there are other limits on what need to be considered when calculating an NOL.
Certain items may not be claimed or deducted when figuring an NOL.
- Deductions for personal exemptions;
- Capital losses in excess of capital gains;
- 1202 exclusions of the gain from the sale or exchange of qualified small business stock;
- Nonbusiness deductions (e.g., alimony and most itemized deductions) in excess of nonbusiness income;
- NOL deductions from other years; and
- 199 domestic production activities deduction.
These items will need to be added back into that negative number. If the amount is still negative, he or she has an NOL and may use it to offset income from other tax years. (using generalizations)
So, it isn’t the simplest thing, but as I have said, a first year tax professional will/should know this.
Please note that there is much more to NOL and that if you are using it, please consult a tax professional.
In my next post I am going to talk more about tax professionals.