One of the ways the reduced corporate tax rate was “paid for” was by reducing the value of certain deductions. One of these was limiting the net operating loss deduction. Net operating losses are generated by showing a negative taxable income on an annual income tax form.
Prior Tax Law for Net Operating Losses
Under the prior tax law a net operating loss could be carried back two years or forward 20 years to offset taxable income. This could offset up to 100% of taxable income. Typically when a co-op had a large net operating loss carryover it would offset taxes for future years and so it would not pay federal income taxes for many years.
New Tax Law for Net Operating Losses
Under the new tax law, net operating losses generated beginning with 2018 tax returns (December 31, 2018 year ends and fiscal years ending in 2019) will not be eligible for any carryback although they will carryforward without expiring. The primary new feature is that a loss carrying forward can only offset 80% of taxable income in a future year. So when there is taxable income generated in a tax year there will be tax to pay regardless of the size of the net operating loss carryforward. The new law does not change the value of net operating losses generated prior to 2018 which can offset 100% of federal income taxes when they are carried forward.
Tax Planning for Losses
The key issue is that a deduction adding $1 to a loss in the current tax year is only worth $0.80 as a loss carrying over to future tax years. This makes it preferable to reduce taxable income in a year before the net operating loss is used. This may be possible using depreciation options for eligible assets purchased in that year.
When a co-op is in a situation where large losses may be generated, such as a food co-op adding a new location, a close consideration needs to be given to depreciation methods and any other options it has to affect that loss. Bonus depreciation can be taken when there is a loss. Section 179 cannot be taken. A co-op has an option of taking the 100% bonus depreciation or of reducing that to 50% bonus depreciation or of forgoing bonus depreciation altogether. Generally it will be better to not take bonus depreciation to minimize the current loss and increase future year depreciation expense.
The optimal choices are only possible to know years later but by making a projection of future income and losses for the next few years it may be clear that there is an optimal decision in the current year.
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About the Authors
Bruce Mayer, MBA, CPA currently serves as a Partner in the Assurance Department, working primarily on audits and tax returns of cooperatives, nonprofits, employee benefit plans and commercial businesses. Bruce performs audits of all kinds and provides consulting services on taxation of nonprofits and cooperatives. Bruce enjoys helping clients solve problems and providing clients advice on accounting and tax strategies that meet their needs.
Kyle Schaaf is a Manager in Wegner CPAs’ Assurance Department. Since joining the firm in June 2010, he has worked on the audit staff performing tax return preparation, financial statement and compliance audits of a number of different not-for-profit organizations. Kyle has also worked on for-profit engagements, specifically cooperatives, and therefore has knowledge and experience working with a variety of organizations.