Net Operating Losses for Agriculture
Agricultural businesses (“producers”) need to understand the impact of incurring tax losses since there has always been a penalty for having a Net Operating Loss (“NOL”). A producer can no longer rely on the NOL carryforward provisions to result in no federal tax liability in a years after 2020. Managing the timing of your income and deductions is more important than ever in order to minimize your long-term tax liabilities. This article discusses the changes to the rules for NOLs. Therefore, it is important for producers to understand the impact of the rules contained in the Tax Cuts and Jobs Act (“TCJA”) and the subsequent changes in NOL’s usage and elections under the Coronavirus Aid, Relief and Economic Security Act (CARES Act). The new rules create more options but come with burdensome accounting and recordkeeping requirements in order to support NOL deductions.
An opportunity to amend your NOL usage elections for the 2018, and 2019 NOL’s must be filed within three years of the due date, with extensions, of those respective returns. If a producer wishes to use the rules prior to the CARES Act the election must be filed by the extended due date of its 2020 tax return. This option is no longer available under the current rule for non-extended calendar year filers.
The Impact on Agricultural Business NOLs by TCJA
Quick overview: the pre-TCJA NOL tax law allowed a five-year carry back to offset income reported in that year or any subsequent years until the loss was absorb for up to 20 more years. The producer could also elect to carry the loss back only two years or elect to only carry the loss forward for 20 years. The net operating loss carryback could also impact the producer’s income averaging for subsequent years in a positive way. If a producer received a subsidy from the USDA and/or a loan from the CCC, he was only able to deduct a loss equal to the greater of $300,000 or the total net income earned from agriculture over the last five years. This provision essentially prevented a producer from carrying back more than a $300,000 loss in many cases.
Under the new TCJA law, most taxpayers no longer had the option to carryback a NOL An exception applied to certain farming/ranching losses which still allows a two-year carryback for producers. However, losses arising in taxable years beginning after December 31, 2017, the net operating loss deduction was limited to 80% of taxable income before the NOL deduction. Likewise, NOLs that are carried back could only offset 80% of taxable income. Note that the carryback exception is only for agricultural losses. If a producer had net income from their agricultural operation but a large business loss on Schedule C, the producer could only carry back the actual agricultural loss. However, if a taxpayer had a NOL carry forward from 2017 to 2018, the law continues to allow an 100% offset of taxable income until the NOL expires or is used up. This deduction is on a first-in first-out basis.
The TCJA made other changes to how producers can treat NOLs. For tax years beginning after 2017 and before 2026), the maximum aggregate loss that can be deducted in any one year is now $500,000. The law eliminated the old excess farm loss rule as aforementioned and replaced it with the new provision that a taxpayer adds all of its business income, losses and gains together. If this net number is a loss, then it is limited to $500,000 and any excess is carried forward as part of an NOL.
The NOL carried over from other years may not be used in calculating the NOL for the year in question. Capital losses may not exceed capital gains. In addition, non-business capital losses may not exceed non-business capital gains, even though there may be an excess of business capital gains over business capital losses. These rules are very complicated, and your tax adviser should be able to help.
Provisions of the CARES Act
Since producers already could carryback a NOL, IRS has set out, in Revenue Procedures 2021-14 and 2021-29, how taxpayers that have a NOL for a tax year that begins in 2018, 2019, or 2020, all or a portion of which consists of a farming loss, can elect to not apply certain NOL rules contained in the CARES Act, how they can revoke a related election, and how the consolidated group rules affect those actions. A “farming loss” is the lesser of:
1. The amount that would be the NOL for the tax year if only income and deductions attributable to farming businesses are taken into account, or
2. The amount of the NOL for that tax year.
CARES Act provided a five-year carryback period for “any” NOL (not just farm losses) arising in a tax year beginning after December 31, 2017, and before January 1, 2021.
CARES Act further amended the law to provide that the 80% limitation applies only to NOLs arising in tax years beginning after December 31, 2017, that are deducted in tax years beginning after December 31, 2020. Thus, carrybacks from before January 1, 2021 would be 100% deductible
CARES Act provides that a taxpayer with a farming loss NOL for any tax year beginning in 2018, 2019, or 2020, may amend any election related to a farm NOL. However, the rules required an extended calendar year return to meet some requirements under the IRS procedure
How to change an Election
In the case of any taxpayer with a Farming NOL that files a federal income tax return before December 27, 2020, that disregards the above CARES Act amendments, the taxpayer is treated as having made a deemed election (Deemed Election) unless the taxpayer amends such return to reflect such amendments by the due date (including extensions of time) for filing the taxpayer’s Federal income tax return for the first tax year ending after December 27, 2020. For calendar taxpayers that is the filing of their 2020 tax return that ended four days after December 27 which needed to be extended to meet this requirement.
IRS sets out specifics on making the election for a taxpayer with a Farming NOL, other than a taxpayer making a Deemed Election, may make an Affirmative Election under the CARES Act if--
a. The Farming Loss NOL arose in any tax year of the taxpayer beginning in 2018, 2019, or 2020; and
b. The taxpayer satisfies all of the conditions described below:
1. The taxpayer must make the election on a statement by the due date, including extensions of time, for filing the taxpayer’s Federal income tax return for the taxpayer’s first tax year ending after December 27, 2020.
2. The top of the statement must state: "The taxpayer elects under § 2303(e)(1) of the CARES Act and Revenue Procedure 2021-14 to disregard the amendments made by § 2303(a) of the CARES Act for taxable years beginning in 2018, 2019, and 2020, and the amendments made by § 2303(b) of the CARES Act that would otherwise apply to any net operating loss arising in any taxable year beginning in 2018, 2019, or 2020. The taxpayer incurred a Farming Loss NOL, as defined in section 1.01 of Rev Proc 2021-14, in [list each applicable taxable year beginning in 2018, 2019, or 2020]."
3. The taxpayer should also attach a copy of the statement to any original or amended Federal income tax return or application for tentative refund on which the taxpayer claims a deduction attributable to a two-year NOL carryback pursuant to the Affirmative Election. (Rev Proc 2021-14, Section 1)
Some taxpayers who made a Deemed Election may have had their two-year carryback claims, as reflected on their applications for tentative refund or claims for refund that were filed before December 27, 2020, rejected by IRS. The Revenue Procedure sets out steps that such taxpayers may take to pursue those claims under the pre–CARES Act rules.
A taxpayer that elected not to have the two-year carryback period apply to the farming loss portion of a Farming Loss NOL incurred in a tax year beginning in 2018 or 2019 may revoke that election if the taxpayer
a. Made that election before December 27, 2020;
b. Makes the revocation by the date that is 3 years after the due date, including extensions of time, for filing the return for the tax year the Farming Loss NOL was incurred; and
c. Attaches a statement to an amended return for the loss year, that states at its top: “Pursuant to section 4.01 of Rev Proc 2021-14 the taxpayer is revoking a prior §172(b)(1)(B)(iv) or Code Sec. 172(b)(3) election not to have the two-year carryback period provided by Code Sec. 172(b)(1)(B)(i) apply to the Farming Loss NOL, as defined in section 1.01 of Rev Proc 2021-14, incurred in the taxable year.”
For purposes of the Revenue Procedure, the term "taxpayer" includes a consolidated group. The Revenue Procedure indicates how the above rules from the Revenue Procedure apply to consolidated groups. For example, it defines NOL, indicates how the consolidated group makes the various elections, provides consequences of the Affirmative Election and the Deemed Election, and indicates how to apply the 80% limitation.
For partnership or S corporation, the NOL rules apply at the partner or shareholder level. Each partner’s distributive share and each S corporation shareholder’s pro rata share of items of income, gain, deduction, or loss of the partnership or S corporation are considered in applying the limitation under the provision for the taxable year of the partner or S corporation shareholder. This adds complexity to accounting requirements. The detail for the consolidation provisions, partnership and S corporations are beyond the scope of this article.
Rules to Consider on Carry Forward Losses
There are additional rules that apply if a taxpayer’s marital status is not the same for all years involved with a NOL carryback/carryforward periods. Only the spouse who had the loss can claim the NOL deduction. On a joint return, the NOL carryback deduction is limited to the income of the spouse with the loss. The refund for a divorced person claiming a NOL carryback against a joint return with a former spouse cannot be more than the taxpayer’s contribution to taxes paid on the joint return. The tax code sets forth a step-by-step procedure to be used in calculating the portion of joint liability allocated to the taxpayer with the NOL carryback. Changes in filing status are treated similarly for those who use a mix of married filing joint and married filing single on returns in the carryback or carryforward years.
Note a NOL that has been carried forward is deductible on a decedent’s final income tax return. It cannot be carried over to a decedent’s estate. Also, a surviving spouse cannot carry over an NOL of a decedent to a subsequent year.
Be aware that a simple NOL carryforward schedule will not be adequate to maintain the deduction under audit. A taxpayer must keep the underlying tax support that created the loss.
Planning Options
Producers should attempt to estimate their taxable income before the end of the year and take actions to create a small income. However, if income is overestimated post year options are available to reduce the NOL:
Elect out of 100% bonus depreciation on some or all asset classes
Use Section 179 to reduce taxable income to appropriate levels
Do not make the de minimis election to expense all assets under $2,500
Elect to capitalize all repairs
Elect to capitalize appropriate costs like fertilizer
Elect to bring some deferred payment contracts into income in the current year
Remember, a NOL has a penalty element. The penalty includes the loss of itemized deduction, at a minimum the standard deduction bracket, and the ability to qualify for some child and earned income credits. In addition, deductions may be lost for, IRA contribution and health insurance costs and it can substantially reduce the benefit of any Section 199A deduction. However, understanding the NOL rules can come into play to soften the blow of unavoidable operating losses.
Summary
It is important for producers to understand the impact of the changes to the NOL rules and the current opportunity to amend related elections. Consideration should be given to the more burdensome accounting and recordkeeping that accompany the NOL requirements. Remember a NOL has a penalty element, and a producer can no longer rely on the NOL carryforward provisions to result in no federal tax liability in future years. An overall multiyear tax savings can be realized by limiting NOL’s and by proper allocating tax deductions to the years that provide the maximum tax benefits. Consideration should be given for filing extension of time to file for your return. This will maximize your time to do tax planning and for making the most beneficial income tax elections. Be aware that NOL’s may easily be lost by a change in filing status and or death. The new tax law continues an add complexity to tax planning. Producers will need to spend even more time before yearend to determine the appropriate amount of taxable income or in certain cases, net operating losses. It won’t be easy to get to the right number. Your tax adviser may be of help in your quest to minimize your over tax liability over a number of years. Do not leave tax dollars on the table because of lack of planning and the making of the best long term tax elections.