Question

There is no answer to the Chapter 3 discussion question 13 for Pearsons Federal Taxation 2020. I want to make sure the answer I have is correct. Here is the question:

Crane Corporation incurs a $75,000 NOL in the current year. In which years can Crane use this NOL? What limitations might apply?

Answer 1

NOL- Net Operating Loss: For income tax purposes, a net operating loss (NOL) is the result when a company's allowable deductions exceed its taxable income within a tax period. The NOL can generally be used to offset the company's tax payments in other tax periods through an Internal Revenue Service (IRS) tax provision called a loss carryforward.

How a Net Operating Loss (NOL) Is Used?

A net operating loss (NOL) may be carried forward to offset taxable income in future years in order to reduce a company's future tax liability. The purpose behind this tax provision is to allow some form of tax relief when a company loses money in a tax period.

KEY TAKEAWAYS

• A net operating loss (NOL) exists if a company's deductions exceed taxable income.
• A NOL can benefit a company by reducing taxable income in future tax years.
• The Tax Cuts and Jobs Act made significant changes to NOL rules for tax years beginning in 2018.
• NOLs may now be carried forward indefinitely until the loss is fully recovered, but they are limited to 80% of the taxable income in any one tax period.
• Section 382 limits the carry forward a company can use if it acquires another company with a previous NOL.

NOL carry forwards are recorded as an asset on the company's general ledger. They offer a benefit to the company in the form of future tax liability savings. A deferred tax asset is created for the NOL carry forward, which is offset against net income in future years. The deferred tax asset account is drawn down each year, not to exceed 80% of net income in any one of the subsequent years, until the balance is exhausted.

Limitation of Net Operating Loss Carry forwards

A net operating loss (NOL) is a valuable asset because it can lower a company’s future taxable income. For this reason, the IRS restricts using an acquired company simply for its NOL’s tax benefits. Section 382 of the Internal Revenue Code states that if a company with a NOL has at least a 50% ownership change, the acquiring company may use only part of the NOL in each concurrent year. However, purchasing a business with a substantial NOL may mean a larger sum of money going to the acquired company’s shareholders than if the acquired company possessed a smaller NOL.

Example of a Net Operating Loss Carryforward

Imagine a company had an NOL of $5 million one year and had taxable income of $6 million the next. The carryover limit of 80% of $6 million is $4.8 million. The full loss from the first year can be carried forward on the balance sheet to the second year as a deferred tax asset. The loss, limited to 80% of income in the second year, can then be used in the second year as an expense on the income statement. It lowers net income, and therefore the taxable income, for the second year to $1.2 million ($6 million - $4.8 million). A $200,000 deferred tax asset will remain on the balance sheet to be carried into the third year.