Question

Habiby, Inc., began operations in 2018 and has the following income and expenses for 2018 through 2021.

2018 2019 2020 2021 Income $180,000 $300,000 $320,000 $320,000 Expenses (280,000) (150,000) (400,000) (220,000) Operating Income $(100,000) $150,000 $(80,000) $100,000

a. What is the amount of tax that Habiby should pay each year? If an amount is zero, enter "0".

2018 $ 2019 $ 2020 $ 2021 $

b. How much would Habiby have paid in tax if the old NOL rules were in place but the corporate tax rate was 21 percent?. If an amount is zero, enter "0".

2018 $ 2019 $ 2020 $ 2021 $

Answer 1

Note:- For tax years beginning January 1, 2018 or later, the TCJA has removed the two-year carryback provision, except for certain farming losses, but now allows for an indefinite carryforward period. However, the carryforwards are also now limited to 80% of each subsequent year's net income. If a business creates NOLs in more than one year, they are to be drawn down completely in the order that they were incurred before drawing down another NOL.

a)For 2018:-

There is Loss for the year 2018.So no tax. Tax amount is 0. NOL carried fwd is $ 100000

For 2019,

Under the new law, an NOL can offset only 80% of taxable income in any given tax year. So 80% of $150000 is $120000.

But the NOL for FY 2018 is $100000 only. So entire $100000 will be setoff.

So taxable income after setoff of carried forwded loss of previous year is $ 50000. ($150000-$100000)

Tax amount= $50000*21%= $ 10500.

For FY 2020,NOL of $80000. So no tax.

For FY 2021, Taxable income is $100000

So we can setoff the loss for FY 2020 to the extent of 80% of $100000 which amounts to $ 80000.

So here the taxable income after setoff of carry forwarede loss is $100000-$80000=$20000

Tax @ 21% on $ 20000 is $ 4200.

b) If Old NOL rules were applicable (rules prior to 1st jan 2018) :- Prior to the implementation of the Tax Cuts and Jobs Act (TCJA) in 2018, the Internal Revenue Service (IRS) allowed businesses to carry net operating losses (NOL) forward 20 years to net against future profits or backwards two years for an immediate refund of previous taxes paid.

For FY 2018:-In our case, there is no scope for backward setoff of losses for FY 2018 since the business has began in 2018 itself. So, the tax liability will not change for the FY 2018. $0 tax.

For 2019, the old rules allowed 100% setoff of the carried forwarded loss. Still our tax liability for FY 2019 will remain unchanged because we have setoff the entire loss for previous year as it was within the 80% limit. So the tax liability for FY 2019 remains unchanged to $10500.

For 2020:-Here there is NOL of $ 80000.Tax liability is 0 for FY 2020. Habiby Inc has an option to setoff the loss with previous years taxable income of $50000. Alternatively, it can carry it forward to FY 2021. If it decides to carry it backward and setoff the tax liability against previous FY 2019, then tax liability for FY 2019 will also be 0 (Since $50000 of taxable income will get utilised)..

For 2021:- Here, if Habiby Inc decided in first place to carry forward the entire loss of $80000 to FY 2021, our answer in point a remains unchanged as $4200.

However, if habiby Inc had setoff its loss backward against the profits of FY2019, then the unutilised loss for FY 2020 would amount to $ 30000. ($ 80000-$50000). So during FY 2021 only balance $30000 will be setoff. and remaining taxable income amounts to $70000.

Tax on $ 70000@21% is $14700.