 Hello and welcome to this session. This is Professor Farhad in which we will discuss net operating loss for short NOL Specifically, we're going to be looking at net operating loss for Corporation and that operating loss or an NOL arises and attacks here in which the corporation has deduction Greater than income simply put you incurred a loss Why you have more deductions more expenses than the income than the corporation generated. Well, that's fine So, what is what is the importance of that? Well, let's take a look at two companies and compare their tax liability If the NOL did not exist and see the unfairness when your business is cyclical versus stable Let's look at two corporation Adam and Avi's corporation started their business in year one two different corporation Over the first five years Adam Corp reported the following income 20,000 loss of 1060 taxable income of 70 in year three a loss of 120 taxable income of 150 Avi's Corp on the other hand their their income is stable and it was 12,000 For the five years year one to year five now if we take 12,000 multiplied by five over five years Avi made 12,000 times five $60,000 also if we net out Adams corporation 20 minus 160 plus 170 minus 120 plus 160 Also would average the same amount over five years. Now. Let's take a look at their tax bill assuming No, NOL exists. No net operating loss then we'll explain exactly how to use the net operating loss For year one assuming attack corporate tax rate of 21% Adam will pay $42,000 on the 20,000 Avi will pay 2250 based on 12,000 then year two Adam did not make any profit no net income therefore there's no taxes. Avi would pay 2250 year three Adam will pay 37,500 because the net income was 170 the taxable income for the corporation year for no income year five thirty one thousand five hundred Avi at the same time is paying 21% over the next over the five-year period If we add up all the tax bill that avi's pay 12,600 if we add up the tax bill that Adam's pay Adam corporation is 71,400 although over four years they both made $60,000 60 K. So The Congress said look a biz the business is a continuation simply put Your business might be cyclical it could go up it could go down Your business is stable. Well in some years you might be making a lot of profit and others not because that's gonna be years Where you you're gonna make a lot of investments and Advertising in R&D until you make more profit once you have a product Well, you should not be penalized for this simply put your losses in Year two and your losses in year four. You should be able to deduct them in future years So simply put your business between year one and year five is Continuous it you cannot separate it each year separately We have to look at it as continuous and as a result certain expenses will be taken in future years And to show you exactly where everything goes if we look at the 1120 the corporate and if we look at exactly line 21a we see a line that says net operating loss deduction Simply put the deduction that you did not use in prior years You would use in the years where you do have taxable income before we proceed any further Most likely you are a student or a CPA candidate and I would like to share with you an announcement about my company farhatlectures.com Farhat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles My accounting courses are aligned with your accounting courses broken down by chapter and topics My resources consist of lectures, multiple choice questions, true-false questions as well as exercises Go ahead start your free trial today. No obligation. No credit card required Following points must be giving a great attention when determining NOL for corporation You have to be aware of those one an NOL carried forward from the previous tax here should not be deducted when computing the current NOL Simply put you cannot use NOL from year one to create an NOL in year two Basically, you're double-dipping. So that's not allowed to the dividend receive deduction limitation If you don't know what dividend receive deduction just simply put it's simply a deduction It has a certain limitation that applies when determining the corporate taxable income are disregarded when determining the NOL If the deduction of the total DRD creates or increase the corporate NOL Simply put if the DRD create an NOL or increase the NOL you will disregard the limitation while you're computing this deduction Three and we'll work an example illustrating this point But if you don't know what a DRD is it just simply put that's a deduction and it has certain limitation The computation of NOL should be made before any deduction for a charitable contribution So you determine your NOL before you determine before you take your charitable contribution deduction Just simply put you cannot take your charitable contribution to create an NOL for you a Capital loss carried over or carried forward from the previous year can be deducted however against Capital gains of the current year when the when determining current NOL So you could use capital losses carried forward But not NOL carried forward to offset capital gain in this year in order to determine NOL So that is allowed now the best way to illustrate this is to take a look at an actual example Let's assume for the year for the current tax year Mike reported gross income of 250 which included capital gain of 45,000 and In addition Mike received dividend income from XYZ corporation a 50% owned corporation of $60,000. This is gonna create a dividend received deduction It also had operating loss of 260. This is for operating the business So we're gonna determine Mike's NOL for the current year giving that it had a capital loss carried forward of 20,000 we're gonna assume that we have a carried forward loss of 20,000 well and Determining the current NOL Mike may deduct the capital loss carried forward against the capital gain remember we have 45,000 of gains right that's included in the income and this loss can offset those gains That's fine. We can do that in addition Mike owns 50% of XYZ corporation Therefore a deduction a dividend receive deduction of 65% is allowed It's the amount 60,000 which is the amount of the dividend times 65% which is 39,000 the taxable income limitation does not apply as the corporation has a negative NOL After deducting the DRD and you will see this one with when we do the computation simply put we're gonna look at gross income 250 minus the carry carry loss carry loss carried forward the 20,000 Minus the operating expenses plus the dividend receive deduction plus the sorry plus the dividend income Minus the dividend receive deduction and as a result. We're gonna have an NOL of 17,000 so what happened is this by using the DRD we created an NOL simply put Let's take a look at it before we computed the DRD. So without the DRD 250 270 minus 270 plus 250 that's gonna give us from operation. That's gonna be negative 20 Negative 20 and negative 20 of capital loss. That's gonna give us negative 40 Plus the dividend receive deduction of plus the dividend income of 60. That's gonna give us plus 20 Then we're gonna bring the dividend receive deduction of negative 37 and that's gonna create an NOL of 17,000 therefore, we will take the full 65% of the dividend receive deduction because it created an NOL for us NOL rules changed over the year So we have to be aware of this and those rules are the same as the individual NOL But I cannot assume that you know them. Therefore, I have to go over these rules NOL arising on or before December 31st 2017. So simply put we're gonna say Everything changes at the end of 2017. So let's see or the beginning of 2018. So this is 2018 going forward Anything that happened before 2018 You could carry it back. You could carry the NOL two years back In 20 years forward Now some of these rules still apply because if you have A loss that was generated in 2016 and you're using it now in 2024 Well, guess what that 2016 loss is being used now? So it can be carried forward. It's still it's still it still applies Now what you need to know about this loss from 2016 You can deduct it up to 100 of taxable income before NOL deduction So you could use this loss Against whatever taxable income you have you don't have to reduce your taxable income because we're gonna see shortly That the rules did change after 2020. Okay, regardless of the year to which they are carried forward. So any any NOL From prior prior to 2018 can offset 100 of your taxable income now NOL that arises after December 31st 2017 which is starting in 2018 all the way to 2020 Okay, can be carried back those NOL arose in this period. They can go back. You can carry them back five years And you can carry them forward forever Bear in mind that NOL arising after 2018 that applies to 2018 2019 and 2020 may be also deducted up to 100 against your taxable income And this is all before you take the NOL deduction. Simply put your NOL from 2018 2019 2020 They can offset 100 of your taxable income NOL arising during this period 2018 2019 2020 That's being used that we still have but now we're using after 2020 which is 2021 2022 forward If that's the case Now the NOL can offset only 80 percent of your taxable income not 100 percent 80 percent the rule have changed It may be deducted up to 80 percent going forward from 2021 now any NOL starting after 2020 which is 2021 and and going forward it cannot be carried back So basically those are the new rules the latest rules is any NOL created after 2020 which is 2021 and forward It can only be carried forward And it offset only 80 percent of your taxable income It cannot offset your total taxable income Okay, and we would look at an example to illustrate what we mean by the 20 percent also any time the carry back option is available which is in 20 in 27 prior to 2018 2018 2019 and 2020 the taxpayer may elect to carry back They net operating loss or just carry it forward They do have this option if the loss is carried back That should be carried back to the oldest year in the carry back period first So you will start with the oldest period first going forward The best way to illustrate this is to take a look at an example and let's assume at the beginning of 2022 Adam in a calendar year C corporation ask Ask your support in preparing its schedule for the NOL carry back and carried forward The corporation started in 2016 and the result are as follow in 2016 They had an income of 30,000 in 2017. They incurred a loss of 60,000 in 2018. They incurred a loss of 32,000 in 2019 they have an income of 42 2020 income of 5,000 and 2021 an income of 10,000 We're going to prepare the NOL schedule for Adam company. Okay, let's look at the rules first So the corporation reported NOL in the years 2017 and 2018 So notice here we have net operating loss of this much Bear in mind that losses from 2017 so this loss here We can go back two years and we can carry it for for 20 years Losses from 2018, which is the 32,000 It can be carried back five years and carried forward indefinitely Adam may carry back. So here's what's going to happen Adam may carry back half half of its 2017 NOL So what what Adam should do is the best if you're the advisor the best is to take this 60,000 because you can go back two years and offset the income The other half is carried forward to 2019 then You did not use it in 2018. It will be carried against 2019 income On the other hand the NOL loss of 2019 is carried forward to 2019 2020 and 2021 Now bear in mind the deduction against the 2021 income because the 2021 now we're in the past 2020 Is subject to an 80% limitation. Don't worry. We're going to look at a schedule explaining everything that I just said Show you how we're going to Find out how much NOL left. Okay starting with 2016. We all see that 2016. We have an income of 30,000 in 2017 we have a loss of 60 What are we going to do with this loss? We're going to take this loss file an amended return and Take back eliminate this 30,000 of income and get a refund We can do that and we have 30,000 left for future NOL remaining NOL from 2017 and for how long can we carry this NOL for 20 years In 2018 we incurred the loss of 32,000 now we have two NOL We have one from 2017 and we have one from 2018 the one from 2018 We could carry it back five years But there's no need because we did not exist up until 2016 and we can carry it forward forever And for 2019 and 2020 it can be used to offset 100 percent of taxable income And after 2020 it can only offset 80 percent of taxable income In 2019 it was a good year. We had an income of 42,000. That's that's good But we don't have to pay any taxes. Why? Because we have already we are carrying If you notice here, we are carrying 62,000 of NOL. So we're going to be using the NOL the first thing obviously which NOL you should use I mean you should use the 2017 because it expires in 20 years, right? The other one does not but it doesn't really matter, but we're going to be using Get rid of this 30,000. So if we have 42,000, we're going to use 30,000 We still have 12,000 of taxable income. Well, that's not acceptable. We are going to go ahead and use 12,000 from 2018 12,000 from 2018 to reduce our taxable income down to zero and the NOL remaining after we After we take the 42,000 remember we had 62,000 in total We offset it 42,000 of income. We still have 20,000 of NOL from the year 2018 Now 2019 we had an income of 5,000 Remember 20 I'm sorry. This is 2020. You had an income of 5,000. Guess what? We have 15,000 of NOL remaining That's fine. And in 2020 we can offset 100 percent. So this is going to be gone as well So we're going to be left with 15,000 of NOL because we can wipe this out the whole thing out using the 2018 loss In 2021 we had 10,000 of income now bear in mind That we are in 2021 and we have a loss that's being carried from 2018. So this 15,000 loss is from year 2018 What does that mean? It means this loss Can offset 80 percent of 10 of the 10,000 we cannot although we have enough NOL To wipe out all of the income of 2010, but that's not allowed going forward. The new rules is you have to take your taxable income multiplied by 80 percent So you can use of the 15,000 you can only use 8,000 so that's fine Better than nothing, right? We can use 8,000 and what's left is 7 NOL That can be carried forward forever Offsetting 80 percent of your taxable income unless the rules changed. Who knows that's always the case At least by the now did not change it. Who knows with the next administration But this is how we compute the NOL schedule Now also bear in mind and I showed you this at the beginning and NOL carried forward is accounted for as a regular business deduction as I showed you online 29a basically it's a deduction. It's an expense. It's going to reduce your taxable Income what should you do now? You should go to farhatlectures.com and work mcqs through faults That's going to help you understand this topic better Whether you are studying for your CPA exam or an accounting student. You need to know this Good luck study hard invest in yourself and stay safe