Tax Planning with the New Corporate Tax Rates and Net Operating Losses

by Steve Braunstein

As we approach the end of 2018, many personal service C-Corporations will have to address the impact of net operating losses in their tax planning strategies, due to the changes enacted by the Tax Cuts and Jobs Act. (“TCJA”)

A net operating loss (“NOL”) is created when deductions for the year are more than income. This can apply to certain business entities, individuals, estates and trusts. Under pre-TCJA law, an NOL for any tax year was generally first carried back two years, and then carried forward 20 years. Taxpayers could elect to forego the carryback.

The TCJA repeals the general two-year NOL carryback. The Act also provides that NOLs may be carried forward indefinitely. This is in effect for NOLs arising in tax years ending after December 31, 2017. This effective date means that NOLs that arose in tax years ending before January 1, 2018, will be subject to the pre-TCJA law.

In past years, many of our small business personal service corporations managed their taxable income to an amount close to break even or a small taxable loss. They did this by paying out bonuses to the owners, because the federal tax rate for personal service corporations was a flat 35%. Beginning in 2018, the corporate tax rate was reduced to a flat 21% for all types of C-Corporations, including personal service corporations. The change in tax rates coupled with the treatment of net operating losses generated after 2018 will likely impact the tax planning strategies for these types of businesses.

For net operating losses generated after 2017, and once the pre- 2018 NOL is utilized in full, a C-Corporation will be limited to using the NOL Deduction in an amount equal to 80% of the taxable income, determined without regard to the NOL deduction. Previously, a C-Corporation could use an NOL to offset 100% of their income.

For example, under pre-TCJA law, if a business generated a loss of $100,000 in 2018 and then had taxable income of $100,000 in 2019 they would have zero taxable income for 2019, because they could net the full 2018 loss with the 2019 income. Under the new law, in the second year when the business generates $100,000 of income, they will only be able to utilize $80,000 of the NOL, resulting in taxable income of $20,000 and the corresponding federal income tax at 21%. The remaining $20,000 will carryforward indefinitely until it is utilized.

With the end of the year quickly approaching, it is important for your personal service C-Corporation to understand the NOL’s they have available and consider when to utilize them, given the current low federal corporate tax rates. The treatment of an NOL is just one of the many TCJA changes that taxpayers will need to consider as they plan to minimize their 2018 tax obligation.