If your cooperative is taxed as a corporation and has had losses in past years or may have them in the future the rules have changed for how those losses can offset income.
As a brief definition net operating losses (NOLs) are generated by showing a negative taxable income on an annual cooperative income tax form. These losses are not lost but can offset income in other years under a set of rules that change periodically.
One of the ways the reduced corporate tax rate implemented in 2018 was “paid for” was by reducing the value of NOLs. When COVID upended the economy these net operating loss rules were temporarily suspended for 2018 to 2020. That suspension ends with 2021 returns so these limitations apply again.
Prior Tax Law for Net Operating Losses
Under the prior tax law, for 2017 tax forms and before, a NOL 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 NOL carryover it would offset income for several future years and so it would not pay federal income taxes at all until the NOL was used up.
Under COVID rules applicable to the 2018, 2019 and 2020 tax forms NOLs could be carried back 5 years or carried forward indefinitely to offset income.
Current Tax Law for Net Operating Losses
For a loss incurred on a 2021 tax return and future years the loss cannot be carried back to prior years but carries forward indefinitely.
The current law does not change the value of NOLs generated prior to 2018 which can offset 100% of federal income taxes when they are carried forward. However, losses incurred on the 2018 form and years after that can only offset 80% of taxable income in a future year. So when there is taxable income generated on a 2021 income tax return and for future returns and the NOL originated with a 2018 or subsequent year there will be tax to pay regardless of the size of the net operating loss carryforward since an NOL can only offset 80% of the 2021 taxable income.
Two examples for federal taxes:
- 2021 taxable income before the NOL is $100,000.
- NOL of $1,000,000 carrying over from 2018, 2019 and 2020.
- The NOL can only offset 80% of 2021 income so there will be tax on $20,000 of income to pay for 2021.
- 2021 taxable income before the NOL of $100,000.
- NOL of $100,000 carrying over from 2017 or before.
- The NOL will offset 100% of 2021 income and there will be no tax to pay for 2021.
Tax Planning for Losses
The key issue is that when there is positive net taxable income in a year then tax will be paid if the NOL carried forward originated on a 2018 or subsequent year income tax return. So if there is expected to be income a co-op should consider if estimated taxes need to be paid.
For tax planning a deduction adding $1 to a loss in the current tax year may only be worth $0.80 as a loss carrying over to the first profitable future tax year. If there is a choice in tax methods generating a large loss is typically not going to be tax efficient. Careful consideration needs to be given to depreciation methods and any other options the co-op has to affect that loss. Generally it will be better to not take bonus depreciation so that a co-op minimizes the current loss and increases future year depreciation expense.
Of course, a co-op can use patronage dividends in this mix to affect the taxable income, NOLs, and taxes to pay.
The optimal choices may only be known 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.
States Get In On This Change
A number of states adopted this 80% limitation on NOLS prior to 2021 and many more will be using this for 2021 and beyond. Again tax planning will be needed, and state estimated taxes may be advisable, in any year where there is expected to be positive net income. Here are the states that have adopted the federal 80% limitation on NOLs – AK, AZ, CO, DC, GA, HI, KY, MN, NM, and SC. States do have many unique NOL rules so the 80% limitation is only one of several issues to consider.
If your co-op does have losses carrying forward you will still need to consider if taxes will be owed in any year there is net income.