Last year's CARES Act for COVID-19 relief brought with it a lot of changes to the tax code that may benefit freelancers. One of the key changes that may have gone under your radar is the loosening of restrictions on the net operating loss (NOL) deduction, which were put in place as part of 2017's Tax Cuts and Jobs Act.
If your freelance revenue was lower this year and you sustained losses, you may be able to use this NOL change to lower your tax bill—or even get a refund.
What’s an NOL and how does it impact me?
In simple terms, an NOL is a situation where your business deductions exceed your business income. When the difference between the two is so wide that it offsets other taxable sources of income, you may result in having negative taxable income on your current year tax return. That's an NOL.
For freelancers whose income varies from year to year, you could have an NOL in some years (when income is lower) and have other years where your income is higher. Using the NOL deduction, you can carry the NOL losses forward (or back) to lower your business' tax burden in the good years.
What does the new rule do?
The CARES Act temporarily reinstated a carryback period for all NOLs generated in years beginning after Dec. 31, 2017, and before Jan. 1, 2021 (i.e., it applies to tax years 2018, 2019, and 2020). The carryback period for these tax years is five years under the CARES Act , so if you had an NOL in the 2020 tax year, you could carry it back to the 2015 tax year, if you had taxable income then, and potentially realize a tax refund. You can also carry a NOL forward so you do not have the hassle of amending tax returns. However, if you are looking to reduce your taxes now, this won’t be an effective strategy.
I had an NOL. What do I do now?
Did you have a loss in 2018 and 2019 and do not want to carry back the losses? If so, you need to make sure you identify this on your 2020 tax return and waive the carryback. The IRS is granting a six-month extension on the due date to file paperwork with respect to the carryback of an NOL that arose in any taxable year that began during calendar year 2018 and that ended on or before June 30, 2019. Individuals must file Form 1045 and corporations file Form 1139.
The CARES Act NOL guidance also includes provisions to disregard certain amounts of foreign income subject to transition tax that would normally be included as income during the five-year carryback period and the temporary suspension of the TCJA’s 80% limitation on taxable income applied to all NOLs incurred in tax years beginning after December 31, 2017. The CARES Act suspends this 80% taxable income limitation, so you can carry forward 100% of your NOL to fully offset taxable income in tax years beginning before January 1, 2021.
The CARES Act is providing taxpayers with a short window of opportunity to temporarily use the NOL deduction to their advantage. Freelancers with NOLs for tax years 2018, 2019, and/or 2020 could be able to reduce their taxable income and create or increase their opportunity for a tax refund this year with these changes, which could be one small positive from the overall negative effect of COVID-19 on many businesses.
Jonathan Medows is a New York City-based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He provides tax, accounting and business articles for freelancers on his website, http://www.cpaforfreelancers.com, which also features a blog and a comprehensive freelance tax guide. Please note, due to the high volume of inquiries in regard to COVID-19, Jonathan is not able to respond to individual requests for information at this time.