You recently told me you were expecting to show a loss this year, with deductions that exceed your income, resulting in negative taxable income. I would like to address whether and how the loss can generate valuable tax benefits for you.
The first step involves calculating the loss to exclude some deductions, such as personal exemptions and certain non-business deductions. If, at the end of this computation, there is a loss, that loss is considered a net operating loss (NOL), which can provide you big tax benefits.
You can benefit from an NOL using one of two options. The first provides you instant cash and the second provides future savings.
The tax rule is if you generate an NOL in a tax year, it becomes a deduction that you first carry back two years and then carry forward 20 years. The carryback will usually provide you an instant refund from the taxes you paid in a prior year. This is the first way you can benefit from an NOL.
Example. You have an NOL in tax year 2016. You will first carry back the NOL to tax year 2014. If the 2014 carryback does not use up the NOL, you carry the remainder to tax year 2015. If the 2015 carryback does not use up the NOL, you carry the remainder forward to 2017, where you can continue to carry forward and use the NOL year by year for up to 20 years.
To take advantage of the carryback, you must file a claim for a refund related to an NOL within three years of the due date of the return for the loss year. So, if you filed your 2016 Form 1040 return with an NOL on April 15, 2017, you have until April 15, 2020, to file a claim for a refund for tax years 2014 and 2015 due to the NOL carryback.
The second way you can benefit from an NOL is to elect in your tax return to waive the two-year carryback and only carry forward the NOL. You should consider forgoing the carryback and electing the carryforward in the following circumstances:
The carryback would generate minimal or no tax refund.
You have no need for immediate cash from a tax refund.
The NOL deduction will generate greater tax savings in the future than it would in the prior years (i.e., your marginal tax rate will be higher in the future).
You want to reduce your next year’s tax liability due to cash flow issues or so you won’t have to pay estimated tax payments.
If you opt to carry the NOL forward, then the election to waive the two-year carryback must be made on a timely filed return. If the return is filed late, you must carry back the NOL.