When it comes to determining if a business is eligible to claim a net operating loss (NOL), it depends on the financial situation. If a business’ taxable income is less than its allowable deductions in a set tax period, usually a year, then the business can utilize the NOL deduction on future tax obligations. Since some businesses’ profits and losses result from uneven cycles, the Internal Revenue Service (IRS) Code permits businesses to find a balance with their tax obligations.

How a Net Operating Loss Works

Here is an example showing a business’ situation with annual profit/loss summaries:

Year one: High profits and big tax payments due

Year two: Net operating loss incurred

Year three: High profits and big tax payments due

The way a NOL deduction works in the example above is that the losses from year two can be used to offset taxes due in year three.

Net Operating Loss (NOL) = Taxable Income – Allowable Tax Deductions

Referring to the income statement, if the company’s bottom line is a net loss, then the company might be eligible to take advantage of the NOL deduction.

It’s important to keep in mind there have been modifications to what and how businesses may use this. Until recently, the IRS let businesses utilize the carryback method to offset losses to prior years’ tax bills (up to 24 months of tax liabilities), resulting in an immediate refund. However, with the passage of the Tax Cuts and Jobs Act, NOLs were modified. Effective Jan. 1, 2018, or later, the two-year carryback provision was removed (except for select farming losses), but allowed for an indefinite carryforward period. The TCJA also limits carryforwards to 80 percent of each subsequent year’s net income. Additionally, if a business records a net operating loss in more than one tax year, they must be exhausted in the order that the losses occurred. 

The Coronavirus Aid, Relief and Economic Security (CARES) Act permitted NOLs occurring in tax years 2018, 2019, and 2020 to be carried back five years and carried forward indefinitely. However, the exemptions have now expired. Losses that occurred in pre-2018 tax years are still subject to former tax rules, with any remaining losses expiring after 20 years. Beginning with the 2021 tax year, when the Tax Cuts and Jobs Act (TCJA) passed in 2017, it permitted carryforwards of NOLS indefinitely. However, only 80 percent of taxable income can be “carried forward” during a single tax period.

2021 and Forward NOL Example

Year one: NOL $10 million

Year two: Taxable income of $3 million

Year three: Taxable income of $5 million

For year two, with the taxable income’s carryover limit (80 percent) of $3 million is $2.4 million. With the carryover limit subtracted ($3 million – $2.4 million = $600,000), the company’s taxable income will be $600,000 for year two. The remaining NOL of $7.6 million will be considered a “deferred tax asset.” Looking at year three, 80 percent of the year’s $5 million in taxable income equals $4,000,000 in a carryover limit. Subtracting $4 million from $5 million in year three’s taxable income, the business will have $1 million in taxable income, and $3.6 million will be the remaining NOL balance at the end of year three. 

With the tax code continuing to evolve, businesses that stay up-to-date with changes in the IRS Code will make the most of their ability to maximize deductions and reduce liabilities.

Evaluating Net Operating Loss Considerations

September 1, 2023  ·  Accounting News, Blog

⏱ 3 min read

When it comes to determining if a business is eligible to claim a net operating loss (NOL), it depends on the financial situation. If a business’ taxable income is less than its allowable deductions in a set tax period, usually a year, then the business can utilize the NOL deduction on future tax obligations. Since some businesses’ profits and losses result from uneven cycles, the Internal Revenue Service (IRS) Code permits businesses to find a balance with their tax obligations.

How a Net Operating Loss Works

Here is an example showing a business’ situation with annual profit/loss summaries:

Year one: High profits and big tax payments due

Year two: Net operating loss incurred

Year three: High profits and big tax payments due

The way a NOL deduction works in the example above is that the losses from year two can be used to offset taxes due in year three.

Net Operating Loss (NOL) = Taxable Income – Allowable Tax Deductions

Referring to the income statement, if the company’s bottom line is a net loss, then the company might be eligible to take advantage of the NOL deduction.

It’s important to keep in mind there have been modifications to what and how businesses may use this. Until recently, the IRS let businesses utilize the carryback method to offset losses to prior years’ tax bills (up to 24 months of tax liabilities), resulting in an immediate refund. However, with the passage of the Tax Cuts and Jobs Act, NOLs were modified. Effective Jan. 1, 2018, or later, the two-year carryback provision was removed (except for select farming losses), but allowed for an indefinite carryforward period. The TCJA also limits carryforwards to 80 percent of each subsequent year’s net income. Additionally, if a business records a net operating loss in more than one tax year, they must be exhausted in the order that the losses occurred. 

The Coronavirus Aid, Relief and Economic Security (CARES) Act permitted NOLs occurring in tax years 2018, 2019, and 2020 to be carried back five years and carried forward indefinitely. However, the exemptions have now expired. Losses that occurred in pre-2018 tax years are still subject to former tax rules, with any remaining losses expiring after 20 years. Beginning with the 2021 tax year, when the Tax Cuts and Jobs Act (TCJA) passed in 2017, it permitted carryforwards of NOLS indefinitely. However, only 80 percent of taxable income can be “carried forward” during a single tax period.

2021 and Forward NOL Example

Year one: NOL $10 million

Year two: Taxable income of $3 million

Year three: Taxable income of $5 million

For year two, with the taxable income’s carryover limit (80 percent) of $3 million is $2.4 million. With the carryover limit subtracted ($3 million – $2.4 million = $600,000), the company’s taxable income will be $600,000 for year two. The remaining NOL of $7.6 million will be considered a “deferred tax asset.” Looking at year three, 80 percent of the year’s $5 million in taxable income equals $4,000,000 in a carryover limit. Subtracting $4 million from $5 million in year three’s taxable income, the business will have $1 million in taxable income, and $3.6 million will be the remaining NOL balance at the end of year three. 

With the tax code continuing to evolve, businesses that stay up-to-date with changes in the IRS Code will make the most of their ability to maximize deductions and reduce liabilities.

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Disclaimer 

These articles provide general information on tax, accounting, and financial topics for small businesses and individuals. They are educational in nature and are not specific legal, accounting, financial, tax, or other professional advice, and should not be relied upon as such. This content was prepared by Service2Client and may have been reviewed or edited by the website owner for accuracy and compliance. Look for a trust mark below for verification details. No representation is made that any approach described will achieve a particular result, and no regulatory or professional body has reviewed or endorsed this content. Because each situation is different, readers should consult a qualified professional about their specific circumstances before acting. Images accompanying these articles are protected by copyright and may not be copied or reused.

When it comes to accounting for capital assets, specifically depreciating capital assets, the Governmental Accounting Standards Board (GASB) provides guidance to state and local governments for accounting processes. The GASB is responsible for the generally accepted accounting principles (GAAP) for the private sector (corporate and business accounting), and it works to promote clear, consistent, transparent, and comparable financial reporting.

One of the three primary GASB pronouncements that impact how these agencies manage their fixed assets includes Statement No. 34, which requires all government entities to use accrual accounting. In addition, such entities must depreciate their capital assets according to its guidelines.

Under the section titled “Basic Financial Statements and Management’s Discussion and Analysis for State and Local Governments,” Statement No. 34 mandates when entities must comply depending on the entity’s annual revenues. Entities with $100 million plus must comply beginning with their first fiscal year after June 15, 2001. Entities with annual revenues of between $10 million and $100 million must comply starting with their first fiscal year post-June 15, 2002. Entities with annual revenues of up to $10 million must comply by their first fiscal year after June 15, 2003.  

Capital Assets Overview

The first step in determining a capital asset is to ensure it has a useful life greater than a single reporting period. Examples of capital assets include vehicles, easements, buildings, land and land improvements, and infrastructure (tunnels, bridges, roads, lighting systems, etc.). When defining infrastructure, it must be something that can be used for the long term; generally is stationary, and when a building is looked at, it’s included only if the building is integral to a network of infrastructure assets.

When it comes to reporting capital assets, they should be reported at their historical costs (inclusive of installation and freight charges). For donated assets, they should be recorded at their fair market value at time received.

Depreciation Expense Reporting Considerations

When an asset is identified with a specific function, it’s recommended to be a direct expense. This includes appropriate assets that are attributable to a unique department or role. If the asset is used by many different departments and there are depreciation expenses, they should be proportionate to how each department uses the respective assets. Additionally, if an asset function across multiple departments or across citywide functions, its depreciation expense is not categorized as a direct expense but rather as a separate line in the Statement of Activities.

Whether it’s straight or declining balance methods (such as double declining balance and 150 percent declining balance), it is done over the asset’s useful life. When it comes to determining an asset’s useful life, government entities can base their calculations on their own past internal experience for similar needs, how other government entities treated similar asset classifications that are publicly available, or industry or professional organization’s published guidelines. Condition and the expected service life are two important factors to be considered.

Another important factor in how depreciation is calculated depends on how assets themselves are classified. For example, it can be done through the following lenses:

• Individual assets
• Classes of assets
• Networks of assets
• Subsystems of a network of assets

Looking at the last two ways to analyze these assets for depreciation, rural roads, state highways, and Interstate highways can be broken down into three discrete systems, also referred to as a subsystem of the network. However, if all three different transportation systems are grouped together, the bigger system would be a network of infrastructure assets or a network of assets.

With capital assets expected to be a part of governments’ budgets, understanding the intricacies is essential to ensure standards are met.

How to Account for Capital Assets

August 1, 2023  ·  Accounting News, Blog

⏱ 4 min read

When it comes to accounting for capital assets, specifically depreciating capital assets, the Governmental Accounting Standards Board (GASB) provides guidance to state and local governments for accounting processes. The GASB is responsible for the generally accepted accounting principles (GAAP) for the private sector (corporate and business accounting), and it works to promote clear, consistent, transparent, and comparable financial reporting.

One of the three primary GASB pronouncements that impact how these agencies manage their fixed assets includes Statement No. 34, which requires all government entities to use accrual accounting. In addition, such entities must depreciate their capital assets according to its guidelines.

Under the section titled “Basic Financial Statements and Management’s Discussion and Analysis for State and Local Governments,” Statement No. 34 mandates when entities must comply depending on the entity’s annual revenues. Entities with $100 million plus must comply beginning with their first fiscal year after June 15, 2001. Entities with annual revenues of between $10 million and $100 million must comply starting with their first fiscal year post-June 15, 2002. Entities with annual revenues of up to $10 million must comply by their first fiscal year after June 15, 2003.  

Capital Assets Overview

The first step in determining a capital asset is to ensure it has a useful life greater than a single reporting period. Examples of capital assets include vehicles, easements, buildings, land and land improvements, and infrastructure (tunnels, bridges, roads, lighting systems, etc.). When defining infrastructure, it must be something that can be used for the long term; generally is stationary, and when a building is looked at, it’s included only if the building is integral to a network of infrastructure assets.

When it comes to reporting capital assets, they should be reported at their historical costs (inclusive of installation and freight charges). For donated assets, they should be recorded at their fair market value at time received.

Depreciation Expense Reporting Considerations

When an asset is identified with a specific function, it’s recommended to be a direct expense. This includes appropriate assets that are attributable to a unique department or role. If the asset is used by many different departments and there are depreciation expenses, they should be proportionate to how each department uses the respective assets. Additionally, if an asset function across multiple departments or across citywide functions, its depreciation expense is not categorized as a direct expense but rather as a separate line in the Statement of Activities.

Whether it’s straight or declining balance methods (such as double declining balance and 150 percent declining balance), it is done over the asset’s useful life. When it comes to determining an asset’s useful life, government entities can base their calculations on their own past internal experience for similar needs, how other government entities treated similar asset classifications that are publicly available, or industry or professional organization’s published guidelines. Condition and the expected service life are two important factors to be considered.

Another important factor in how depreciation is calculated depends on how assets themselves are classified. For example, it can be done through the following lenses:

• Individual assets
• Classes of assets
• Networks of assets
• Subsystems of a network of assets

Looking at the last two ways to analyze these assets for depreciation, rural roads, state highways, and Interstate highways can be broken down into three discrete systems, also referred to as a subsystem of the network. However, if all three different transportation systems are grouped together, the bigger system would be a network of infrastructure assets or a network of assets.

With capital assets expected to be a part of governments’ budgets, understanding the intricacies is essential to ensure standards are met.

---

Disclaimer 

These articles provide general information on tax, accounting, and financial topics for small businesses and individuals. They are educational in nature and are not specific legal, accounting, financial, tax, or other professional advice, and should not be relied upon as such. This content was prepared by Service2Client and may have been reviewed or edited by the website owner for accuracy and compliance. Look for a trust mark below for verification details. No representation is made that any approach described will achieve a particular result, and no regulatory or professional body has reviewed or endorsed this content. Because each situation is different, readers should consult a qualified professional about their specific circumstances before acting. Images accompanying these articles are protected by copyright and may not be copied or reused.