Many businesses struggled to turn out a profit or even mitigate losses throughout 2020. Fortunately, the government passed various articles of legislation within the last year in order to help businesses start on the path of financial recovery. During this episode of The Tip Share, RASI Compliance Director, Brian Smith, walks RASI New Business Strategist, Dave Downs, through the most beneficial legislative updates within the last year that all restaurant operators should know about, including NOL Carrybacks provisioned under the CARES Act.
What does NOL mean and what is a NOL Carryback?
Within the last year, the government reinstated NOL Carrybacks as provisioned under the CARES Act. A NOL is a net operating loss that occurs in a trade or business when deductions are greater than income; essentially, a loss used to reduce taxable income in a previous tax year.
A net operating loss that occurred in 2018, 2019, or 2020 can now be carried back 5 years; any unused portion of the loss can be carried forward indefinitely until it is reduced to 0.
How can NOL Carrybacks and The CARES Act benefit restaurants?
The Tax Cuts and Jobs Act of 2017 initially repealed the Net Operating Loss Carryback and only allowed a taxpayer to carry forward their NOL indefinitely until the loss reduced to 0. However, when the Carryback was repealed, taxpayers with a Net Operating Loss were forced to wait until there was a profit in future years to realize that benefit from the Net Operating Loss.
Now, a taxpayer can utilize the last 5 years and offset taxable income with that NOL deduction. The ability to work within a 5-year range for carrybacks will help a business owner recoup some of the taxes paid, and the taxpayer will no longer have to wait for future profits to offset the deduction.
This could prove very beneficial to a business that does not expect to be profitable in the next few years but was profitable in the past. Additionally, with the changes in The CARES Act, the previous limitation put in place by the Tax Cuts and Jobs Act lifted, which restricted the NOL deduction to 80% of taxable income.
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Example of the impact from changes within NOL Carrybacks:
Pre-CARES Act Changes:
- In 2020 a business had a Net Operating Loss of $100,000.
- That loss carries forward to 2021 and beyond to reduce future taxable income.
- This same business has a taxable income of $100,000 in 2021.
- The taxable income can only be reduced by $80,000.
- The taxpayer still has a $20,000 taxable income, even though they had enough Net Operating Loss in the prior year to offset 100% of their income because their NOL deduction was limited to eighty $80,000 or 80%.
Post-CARES Act Changes:
- The same business from our example has a $100,000 loss in 2020.
- With the changes in The CARES Act, it is no longer necessary for the business owner to wait for future profits to carry the loss – the business owner can carryback within the last 5 years.
- The same business had a taxable income of $100,000 in 2015.
- The updated NOL Carryback now reduces the taxable income in our carryback year of 2015 to $0.
- The tax return for 2015 is recalculated and any overpaid tax, according to the new calculations, is refunded to the taxpayer.
- This enables the business owner to immediately realize the benefit when they’re filing their 2020 taxes without having to wait until the next year to reduce their taxable income.
Why would a business owner not apply the Carryback provisions as outlined under the CARES Act?
As with all tax implications, there are exceptions to the rules; Example of a situation where a business owner does not benefit from the updated NOL Carryback legislation:
A net operating loss is carried back, so the taxable income and everything associated with it (tax credits, owners IRA deductions, etc.) is recalculated. This recalculation may create a situation where the taxpayer loses a previously calculated tax credit.
Additionally, the creation of an Alternative Minimum Tax liability in the carryback year essentially reduces the amount of refund that the taxpayer can realize from a net operating loss deduction that’s carried back to 2015.
BEST PRACTICE: Seek the advice of your trusted tax preparer; they will know exactly how the updated legislation can impact a business owner’s taxes within their own unique situation.