Does My Entity Qualify
Claim Net Operating Losses for Refunds
Who Qualifies for NOL Carryback?
As a result of COVID-19 and the unexpected shut down of the national economy, 2020 will likely result in net operating losses for many businesses and individuals through no fault of their own. But what does a net operating loss as defined by the Internal Revenue Service mean for you and your business?
What Kind of Taxpayer Are You?
The Internal Revenue Service (IRS) breaks down who can use an NOL into two separate groups of taxpayers.
1. One group includes individuals, trusts, and estates.
2. The other group is limited to corporations.
The treatment and calculations of an NOL is based on the type of taxpayer, but both types of NOLs typically start at the same point with a net negative taxable income. From this point forward, different things come into play when calculating a taxpayer’s NOL.
Corporations
A corporation has some distinguishing characteristics from individuals. A corporation at its root is a separate and distinct legal entity from the shareholders. It possesses rights and responsibilities similar to an individual. Corporations are also limited liability entities where the shareholder does not have personal liability but is entitled to receive profits.
Not all corporations are subject to taxes at the corporate level. When looking at corporations another distinction must be made by the taxpayer, and this distinction is whether the corporation is either:
-> A C corporation (also referred to as a C Corp.)
-> An S corporation (also known as an S Corp.)
This difference has drastic implications for tax purposes.
C Corps
The United States taxes C Corps. through the corporate entity itself instead of taxing the individual shareholders. The shareholders, however, do not escape tax liability altogether on the profit from the corporation because when shareholders receive profit in the form of dividends, they are subject to tax on it. Essentially the United States taxes a corporation’s earnings twice, but at different levels.
C Corps
Conversely, an S Corp. is generally not subject to income tax at the corporate level. Instead, the income, losses, deductions, and credits are passed through to the shareholders. This pass-through entity operates similarly to a partnership for tax purposes. The NOL from an S Corp. would be subject to certain limitations and pass through to be analyzed as part of an individual taxpayer’s overall income. Not every corporation can elect to be an S Corp. since it requires the satisfaction of certain requirements outlined by the IRS and the election by the S Corp. All shareholders must sign the Form 2553 to elect, otherwise, an election by the S Corp cannot be made.
Partnerships
One more important distinction worth noting regarding S. Corps is a partnership or S Corp. cannot recognize an NOL because they act as pass-through entities. However, according to the IRS Passive Activity and At-Risk Rules, individuals who hold an ownership interest in the partnership or shares in an S Corp. can recognize (with certain limitations) their share of the NOL.
Individuals, Trusts and Estates
Just as in the case of corporations, the specific definition of individuals, trusts, and estates impacts how these entities applying for NOL carrybacks proceed.
Individuals: For tax purposes, individuals also include both single people and married couples.
Trusts: According to Black’s Law Dictionary, a trust is a legal arrangement involving a fiduciary relationship between a person (“beneficiary”) and the person in charge of the trust, (“trustee”). The trustee is obligated to hold or use the property in a manner that benefits the recipient beneficiary.
Estates: An estate is the possessions a person leaves behind upon their death to be distributed to beneficiaries and heirs.
Trusts and estates deal with NOLs in a similar manner as individuals, except for the different forms that must be filed.