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For businesses, they have Net Operating Losses (NOL), if their business deduction is more than business income. For individuals, they have NOL, if their business deduction exceeds business income and nonbusiness income. Generally, individual taxpayers would have a business loses to have NOL. In other words, they may end up having NOL if they have losses from pass-through entities, such as partnerships and S corporation, and losses in schedule C, E, or F in your 1040.There were two ways using NOL before passing the American Recovery and Reinvestment Act of 2009, NOL is generally carried back 2 years for tax refunds, and then the remaining NOL is carried forward for up to 20 years to reduce the future tax liabilities. In another way, all NOL could be carried forward up to 20 years without carrying back. The Act brings a good news to certain small businesses and individuals with NOL in the tax year of 2008. It gives them rooms to play in their tax planning and ease their financial burden. The qualified small business is any business with average annual gross receipts of $15 million or less and has NOL for the tax year beginning or ending in 2008. For individuals, the gross receipts test is applied at the partnership or corporation level. In other words, individuals should combine all their pass-through taxable income to see if it meets the requirement of $15 million gross receipts.
The qualified small businesses and individuals can elect to carryback the NOL up to 5 years. It provides benefits to a lot of qualified small businesses and individuals with NOL in 2008 and taxable income in the past up to 5 years. Before taxpayers have their tax preparer make the election, they should seek advice from a CPA or CFP on their financial planning in order to make the most out of the new rules. There are some issues needed to be considered. The first thing to look at is whether they have taxable income in the past to cover the current NOL. Then, they should analyze how much tax refund they might get in each of the 5 past year if they carry NOL back to those years. Remember, taxpayer can chose to carryback 2, 3, 4, or 5 years .The goal to play this game is to apply losses to years with highest tax rates so to maximize tax refund. Also, taxpayers should consider whether they might have NOL in 2009. The new NOL rule is only applied to the 2008 NOL. For now, the 2009 NOL can only be carried back 2 years. Taxpayers may lose the opportunity to carry back losses to the year of 2007 if he or she elects to carry the 2008 losses back to the year of 2007. Therefore, an earning projection is very important. It may be more benefit to forgo the carryback election to carry the NOL forward to future years than to carry them back in some cases which the company expects big earnings in those years. Because the tax rates are more than likely to rise in the future, by carrying the NOL to those future years, taxpayer may save more taxes and gain more cash flows back to their businesses.
The rule is tricky, so talk to your adviser before making the election and you may end up saving more taxes than you think.