If you’re a business owner, it’s possible that at some point during the year, you’ll have an excess business loss or net operating loss.
It’s expected from time to time — businesses don’t always earn a profit. Fortunately, tax relief options and deductions may be available that can provide crucial tax benefits, especially if you are a small business owner. These can help ease the burden by reducing your tax liability for the current and future years.
However, you’ll need to be aware of some essential factors and limitations to ensure you are taking advantage of all possible tax planning strategies as they pertain to your particular situation.
You’ll need to understand two concepts: excess business loss (EBL) limitations and net operating loss (NOL).
Unfortunately, using business losses to reduce tax liability is not as simple as deducting them from your annual income. The rules governing business loss can be complex and even confusing, especially if you own multiple businesses or operate your business on several different levels at the same time.
This article provides some answers to common questions about excess business loss limitations and Net Operating Loss so that you can make more informed decisions when preparing your taxes.
An excess business loss is the amount your aggregate trade or business deductions exceed your gross trade or business income or gains, plus a threshold amount adjusted for cost of living.
To put it more simply: an EBL refers to the excess amount by which your business deductions are greater than your business income.
In 2017, the Tax Cuts and Jobs Act (TCJA) passage created a provision limiting the extent to which loss can offset income. To put it in simpler terms, you cannot deduct an excess business loss in excess of the threshold amount, and instead, that excess carries forward as a net operating loss, subject to NOL rules.
For 2022, the threshold amount is $270,000 ($540,000 if Married and Filing Jointly).
For example, imagine you have $500,000 of gross income and $800,000 of deductions from your retail business. Your excess business loss is $30,000.
You can reach this calculation by subtracting gross income from the sum of deductions and the threshold amount combined. [$800,000 – ($500,000 + $270,000)].
Since, in this example, your deductions are greater than the total of income and threshold amount, you would need to treat the $30,000 remainder, which is your excess business loss, as an NOL carryforward to 2023.
It is also important to note that the rules governing how the EBL limitation applies in practice can vary depending upon your circumstances and the type of business you operate.
For pass-through entities (partnerships and S corporations), the excess loss limit applies at the partner and shareholder levels. The partner or shareholder must take each partner’s or shareholder’s share of the items of income, gain, deduction, or loss of the partnership or S corporation into account in applying the excess business loss limitation.
The excess business loss limit applies after the passive loss rules. Under the passive activity rules, you may only deduct losses and expenses attributable to passive activities from passive activities. Generally, passive activities are those in which you may own an interest in the business but does not materially participate. Some activities count as passive by default, such as rental activities.
A net operating loss (NOL) generally means the amount by which your business deductions exceed gross income.
You have a net operating loss when your total allowable deductions are more significant than your total taxable income within a given tax period.
NOLs are the result of losses from the following:
Although the phrase “net operating loss” sounds scary, it can actually benefit your company long-term by reducing taxable in future tax years.
In addition, it is not only businesses that can have an NOL. In certain circumstances, individuals, estates, and trusts may also have a net operating loss.
An individual may have an NOL if adjusted gross income (AGI) minus the standard deduction or itemized deductions is a negative amount, and the negative amount is due to business deductions exceeding business income.
An estate or trust may have an NOL if the taxable income line on Form 1041, U.S. Income Tax Return for Estates and Trusts, is a negative amount, and the negative amount is due to business deductions exceeding business income.
Although the TCJA generally eliminated the carrying of an NOL loss back for two years (with some exceptions such as farming loss, wherein a two-year carryback is the default unless waived), you can still utilize an NOL carryforward.
A tax loss carryforward, or carryover, is a provision that allows you to move a tax loss to future years to offset a profit, which can be beneficial from a tax planning perspective.
Suppose your business suffers losses in one year. In that case, NOL carryforwards allow you to deduct those losses from a future year’s profits, thus enabling you to spread your business’s tax burden across a more extended period of average profitability rather than placing the entire burden on one bad year.
Once you have calculated the NOL for the tax year, you can carry the NOL deduction forward to the following year. However, the IRS limits this deduction to 80% of taxable income by default, determined without regard to the NOL deduction (meaning an NOL cannot entirely zero out taxable income).
Broadly speaking, the NOL that is more than 80% of taxable income for the year is an NOL carryforward.
If you do not use your carryforward up in that year, you can continue to carry it forward until you use it. In general, you can carry it forward indefinitely until you use it up, although you must adjust your carryforward to take the 80% limitation into account.
One exception: This 80% limitation does not apply to property and casualty insurance companies. However, the IRS limits NOL carryforward to twenty years for P&C companies.
It’s also worth noting that when computing your NOL, you will not take the 20% qualified business income deduction (QBID) into account.
In general, you must adjust an NOL carryforward to take the 80% limit into account.
To claim an NOL carryforward, you can list your NOL deduction as a negative number as “Other Income” on Form 1040. Be sure to attach a statement that shows how you computed the NOL deduction. If you deduct more than one NOL in the same year, your statement must cover each NOL.
In the case of multiple NOL deductions, apply the NOLs against modified taxable income in the same order you incurred them, starting with the earliest.
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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
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