Under the old tax laws, farmers could carry back unlimited net operating losses (NOL) five years and offset any tax paid during the previous five years. As an example, assume a farmer generated $200,000 of net taxable income each year from 2012 to 2016. In 2017, she incurred a $1 million NOL. She could carry that full $1 million loss back to 2012 and get an income tax refund for all taxes paid during 2012-2016.
Starting in 2018, this is no longer the case. Farmers are now only allowed to carry back farm NOLs two years and can only offset up to 80% of taxable income (although this provision may be good since it will keep the income taxed at the lower rates in many cases). However, NOLs are now only allowed up to $250,000 for non-married taxpayers and $500,000 for married taxpayers. As an example, let's use the same numbers as our first example. She is single. In this case, she can carry back $250,000 of the $1 million loss to 2016 and offset $160,000 (80% of $200,000) and then carry forward the remaining $90,000 into 2017 and use it there. The remaining $750,000 is then carried forward to 2019.
The amount in excess of the $250-500,000 limit is called the excess business loss (EBL). The IRS will be releasing proposed regulations on these rules soon and there is some concern that any NOL will be treated at a business loss and thus the EBL rules will apply in each following year. This can drastically reduce the benefit of the NOL. Here are a couple of examples:
Assume Mary carries forward an EBL of $2 million and during 2019, she has farm income of $500,000 and has no other income. The first question that arises is that EBL should be allowed to offset farm income, however, the NOL rules only allow you to offset 80% of taxable income, so she may be only able to deduct $400,000 of the loss and owe tax on the remaining $100,000.
Now, let's add $1 million of income from an IRA that she cashed in during the year since she assumed she could offset that income with her NOL carryover. If we add the farm income and the IRA income together we get $1. 5 million. 80% of this is $1.2 million and she will be taxed on $300,000. That does not sound too bad. However, there is a very good chance that the IRS will state that she can only deduct a $250,000 EBL loss against the IRA income resulting in her owing tax on $750,000. That is probably not the result she would like.
Another bad feature of a NOL for our farmers is that it does not reduce self-employment tax and it does not allow the farmer to deduct any Section 199A deduction including the cooperative DPAD deduction. Because of these issues we will likely try to keep NOLs to a minimum in the future. We may elect out of bonus depreciation, elect to capitalize repairs, bring deferred payment revenue into current year income, etc.
We will keep you posted on the new regulations when they come out.