Beginning in 2021, a business can’t carry back a net operating loss (NOL) and get an immediate refund of needed cash.
Congress passed the Tax Cuts and Jobs Act (TCJA) which reduced your ability to take advantage of business losses. However, due to Covid-19, Congress retroactively suspended the new rules for tax years 2018 through 2020. This allowed businesses who suffered tax losses to carry back a loss to previous years and get refunds which could immediately help their business.
The Cares Act changed the TCJA limitations for NOLs for tax years 2018 through 2020. The Cares Act allowed carry back the NOL for 5 years and carry it forward indefinitely. Additionally, an NOL could offset up to 100 percent of your taxable income.
Beginning in 2021, the Cares Act loss rules no longer apply. If you have a business loss, you can no longer carry it back and get an immediate refund. Additionally, an NOL can only be used to offset up to 80% of your taxable income before your 20% Section 199A deduction.
The new NOL rule could have a negative impact on businesses that are struggling financially and in need of immediate cash.
Several strategies make your business loss work for you by immediately offsetting income and providing immediate cash.
Most small businesses use the cash method of accounting for tax purposes. When using the cash method, you recognize taxable income when you receive the cash. This strategy is to receive the taxable money this year and pay the deductible expenses next year. You can speed up cash received by accelerating your invoices. Offering discounts to clients who prepay for next year’s services can entice them to pay early. You can increase your efforts to collect aged receivables and can also consider selling aged receivables to a factoring company.
Another strategy is selling your appreciated property. You can use the business loss to offset the taxable gains. Sales of assets with short-term gains and ordinary income will provide the most tax benefit. You can immediately repurchase similar assets since there is no “wash sale loss” rule.
You can use your business loss to take out IRA funds, and the money will be 100 percent tax-free. The business loss will offset the taxable IRA distribution.
Another strategy is converting traditional IRA assets to Roth assets regardless of income. You will include the conversion amounts in your taxable income, but you won’t pay a 10% penalty on the converted amount. The conversion is tax-free, and your converted funds continue to grow tax-free. An additional benefit is that it will reduce future income from required minimum distributions (RMDs). You are not required to RMDs from a Roth IRA account.
By being proactive, you can bypass the NOL rule and take advantage of the business loss immediately.
David Zubler is a tax accountant and Enrolled Agent in East Tennessee, providing tax strategies and representing clients before the IRS and has over 25 years of tax experience.