Today TaxMama® hears from several people in the TaxQuips Forum about this topic. “Net Operating Losses have some special qualities that make them very desirable for tax purposes – even if they result from disasters in an economic sense. It’s important to understand how to use them, or you can waste them.”
Dear Family,
Net Operating Losses (NOLs) arise primarily from three areas on the tax return – business losses, casualty losses, and losses on the sale of business property that has not been fully depreciated.
The special qualities of NOLs include:
1) Being fully deductible, rather than limited to $3,000 per year, like capital losses.
2) Being able reduce all income, not just capital gains.
3) Being able to get refunds quickly, within a couple of months after filing the tax return with the NOL. You simply file a special form, Form 1045 before December of that year.
4) If the losses are higher than all the income on the tax return, you can use them in the past or in the future. (Note: State laws will vary.)
a) Currently, you may carry the losses back to your tax return two years earlier. (In the recent past, you were able to carry the NOL back as far as 5 years.)
b) You can carry the loss forward for 20 years.
c) Whatever you don’t use in the first carryback/carryforward year can be used in the subsequent year.
And therein lies the problem. The average person (who knows about carryforwards) just assumes they can use the losses next year. You may. But only if you make a specific election, with the tax return, saying you want to give up your right to carry the losses back. The tax return with the NOL must include a statement like this:
“Taxpayer elects to forgo the carryback period under Internal Revenue Code § 172(b)(3).”
If you don’t include this statement, you have no choice. You MUST carry the loss back to 2 years ago, then carry whatever is left to future years.
The purpose of the carryback is not to punish you. It was designed to give you the opportunity to get refunds quickly in hard times. By amending the earlier years using Form 1045, you could get a refund in a month or two, instead of waiting until the following year’s tax season.
Not everyone wants to carry losses back. Either that year’s tax bracket is quite low – while the following year’s tax bracket is much higher. Or they don’t want their tax return scrutinized, and to make the audit statute of limitations another year longer.
Also, when you carry the NOL forward in the first place, there is no need for an amended return and no special scrutiny of your tax return.
IRS provides detailed information about how to use an NOL in Publication 536.
And remember, you can find answers to all kinds of questions about Net Opertaing Losses other tax issues, free. Where? Where else? At www.TaxMama.com.
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