At the beginning of October, the New York Times released pages from Donald Trump’s Connecticut, New Jersey and New York 1995 tax returns, apparently reflecting that the Donald declared “other income” of negative $916 million and was prepared to forego any federal income tax liability for up to 18 years by carrying forward this “net operating loss” (NOL). So what is a net operating loss?
An NOL is a loss measured by the excess of allowable deductions over gross income for a given tax year, which results in negative taxable income. Carrying NOLs back or forward greatly assists business enterprises even out significant fluctuations in corporate profitability every twelve months. Not only do NOLs play a significant role in corporate tax planning, they may also be used on personal income returns for losses from limited liability companies, partnerships, and S corporations.
For businesses with levels of income that vary or fluctuate on an annual basis, the benefit of deductions may be lost in taxable years when expenses exceed income. These enterprises may experience greater tax liability over a period of time than businesses in which profits and income are steady, i.e., follow a straight line. This presents a problem for business owners, especially new ones.
As mentioned, there are two ways to use NOLs: carryback (the use of a net operating loss deduction in earlier taxable years) and carryforward (the use of a net operating loss deduction in later taxable years). While the carryover and carryback periods for NOLs have varied in the past, presently, I.R.C. § 172 provides a carryforward period of up to 20 years and carryback period of two years. Thus, an NOL permits the carryover of losses to offset taxable income in prior or future reporting periods; therefore allowing a refund for prior taxable years or reduced tax payments in future ones.
While business enterprises with consistent levels of income that exceed expenses may take the full benefit of deductions on a consistent basis, the gains and losses of some businesses may not coincide with the current calendar year. Not only do NOLs solve this problem, they allow a business to retain capital to encourage further investment in the business. Since many new businesses experience annual losses early in their corporate existence, NOLs may be vital to a company’s ultimate long-term survival.
Almost sixty years ago, the Supreme Court stated the following as the underlying purpose and public policy of the Tax Code’s NOL rules:
“(They) were enacted to ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They were designed to permit a taxpayer to set off its lean years against its lush years and to strike something like an average taxable income computed over a period longer than one year (Libson Shops, Inc. v. Koehler, 353 U.S. 382, 1957).
If you are a business owner in the New York or the Tri-State area and have any questions about net operating losses or any other tax-related issues, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.
