Small business owners can use net operating losses (NOLs) to offset taxable income from other years; however, a recent Tax Court case makes one thing clear: merely intending to start a business does not automatically create a tax-favored loss.
Before the Tax Cuts and Jobs Act (TCJA), taxpayers could carry NOLs back two years and then forward for up to 15 years. The TCJA removed the general two-year carryback, except for certain farms and insurance companies. Now, taxpayers can carry NOLs forward indefinitely. The law also limits a corporation’s NOL to 80 percent of taxable income, and noncorporate taxpayers face caps on losses that offset non-business income. Taxpayers must carry excess business losses forward as NOLs, still subject to the 80 percent limit.
Self-employed individuals and owners of pass-through entities can claim NOLs on their personal returns, which can significantly reduce their taxes. However, the IRS requires taxpayers to show that they actively operated a business. Intention alone does not qualify.
In a recent Oregon case, a couple planned to operate a recreation lodge. Floods, structural damage, and infestations made the building unusable, leading to years of lawsuits. They attempted to claim a large NOL for a tax year when the lodge did not operate. The Tax Court sided with the IRS, ruling that they did not conduct a business during that year and disallowed the claimed NOL.
This case underscores the importance of understanding the rules for claiming NOLs. Working with a tax professional can help you maximize available tax benefits while remaining fully compliant with current laws.
