Among the many changes brought about by the Tax Cuts and Jobs Act (TCJA) are changes to the calculations of Net Operating Losses on individual income tax returns. Losses arising in tax years ending after 2017 can generally only be carried forward (the carry-forward period is indefinite). The two-year carryback period allowed under the prior law has been eliminated. Also, the allowable net operating loss deduction is limited to 80% of taxable income (without factoring in the NOL deduction) for tax years beginning after 2017.
Certain elements of the calculation of the Net Operating Loss generated in a given tax year have been added, changed or removed. For instance, the addback for personal exemptions no longer applies since the TCJA eliminated personal exemptions from the tax return. Also, the allowable Qualified Business Income Deduction, if applicable, must be added back to negative taxable income when computing the NOL.
An important addition to the NOL computation as a result of the TCJA is the requirement to include excess business losses in the Net Operating Loss for a given year. A taxpayer has an excess business loss in 2019 if the total losses from all trades or business exceed $255,000 ($510,000 for married filing joint returns). For 2020 the limit is raised to $259,000 ($518,000 for married filing joint returns). This threshold is adjusted each year for inflation. The term trade or business can include, but is not limited to, Schedule F (farming) and Schedule C (sole proprietorship) activities, the activity of being an employee (W-2 wages), farm rental (reported on Form 4835), and other business activities (reported on Schedule E), and pass-thru income and losses attributable to a trade or business. Income or loss from the sale of business property and farming losses from casualty losses or losses due to disease or drought may also be included. The total amount of excess business losses will be treated as a net operating loss carryover to the following tax year.
For example, suppose that Tom has gross income of $200,000 and deductions of $500,000 from a business and Tom’s spouse, Susan, earns a salary of $150,000 and has investment income of $50,000. Since Tom’s $500,000 business deductions do not exceed gross business income ($200,000) plus the $510,000 threshold, there is no excess business loss and the entire $300,000 net business loss can be used to offset Susan’s income on their joint return. However, if Susan also had a business with gross income of $250,000 and deductions of $600,000, they would have an excess business loss on their joint return. Total business losses would be for Tom ($200,000 – $500,000 = $300,000) plus for Susan ($250,000 – $600,000 = $350,000) = $300,000 + $350,000 = $650,000. Excess business loss = $650,000 – $510,000 threshold = $140,000.
As stated above, the deductible amount Net Operating Loss for losses generated from tax years beginning after 2017 is limited to 80% of taxable income before factoring in any NOL deduction. Losses arising from tax years beginning in 2017 or prior years are not limited to taxable income. For example, suppose that a taxpayer has a $120,000 NOL carryover from 2018 to 2019 arising from 2018 activity and a $40,000 NOL carryover from 2018 to 2019 arising from a 2017 NOL. On the 2019 tax return, the taxpayer has taxable income of $100,000. The deductible amount of the 2018 NOL is limited to $80,000 (80% of 2019 taxable income). The 2017 NOL is not subject to the limit. The total NOL deduction for 2019 is $120,000 ($40,000 NOL from 2017 + $80,000 allowable NOL from 2018). Only $100,000 of this deduction is used to reduce 2019 taxable income to zero. The $40,000 NOL from $2017 reduces taxable income to $60,000. $60,000 of the loss from 2018 is then used to reduce 2019 taxable income to $0. The NOL carryover from 2019 to 2020 is $60,000 (remaining amount of 2018 NOL).
By David Johnson, CPA