Conversion Strategy for Your Business Losses after Tax Reform

Tax reform made a lot of good changes in the tax law for the small-business owner.

But the changes to the net operating loss (NOL) deduction rules are not in the good-changes category. They are designed to hurt you and put money in the IRS’s pocket.

Now, if you have a bad year in your business, the new NOL rules are designed to stop you from using your business loss to find some immediate cash. The new (let’s call them bad-for-you) rules certainly differ from the prior beneficial rules.

Old NOL Rules

You have an NOL when your business deductions exceed your business income in a taxable year.

Before tax reform, you could carry back the NOL to prior tax years and get refunds of taxes paid in those prior years.

Alternatively, you could have elected to waive the NOL carryback and instead carry forward the NOL to offset some or all of your taxable income in future tax years.

New NOL Rules

Tax reform made two key changes to the NOL rules:

You can no longer carry back the NOL (except for certain qualified farming losses).
Your NOL carryforward can offset only up to 80 percent of your taxable income in a tax year.

The changes put more money in the IRS’s pocket by

eliminating your ability to get an immediate tax benefit from your NOL carryback, and
delaying your ability to get tax benefits from future NOL carryforwards.

We are bringing the NOL rules to your attention in case you need to do some planning with us. We likely have some strategies that can help you get some immediate benefits from your business loss. Listed below is a strategy that we commonly use with our South Loop tax preparation business owner clients.

Conversion Strategy: Roth IRA Conversion

If you have traditional IRA assets, you can convert them to Roth IRA assets regardless of income. You include the conversion amounts in your taxable income, but you don’t pay the 10 percent penalty on the converted monies. This brings up a planning opportunity for your business loss. Use the loss to offset the income that you had to include because of the conversion to a Roth IRA. If your loss can offset the entire income inclusion, the conversion is tax-free to you, and the tax-free converted funds continue their growth tax-free inside the Roth IRA. You’ll also reduce future required minimum distributions (RMDs) after age 70 1/2 since you don’t take RMDs from a Roth IRA account.5

Example: In 2018, John, who is single, takes the standard deduction and has a Schedule C loss of $30,000. John has no other tax items on his tax return. John has $55,000 in traditional IRA assets. John can convert $42,000 ($30,000 loss plus $12,000 of standard deduction) of his traditional IRA to a Roth IRA in 2018 and pay no tax on the conversion amount.
Although we’ve given you the basics, this is not an all-inclusive article. Should you have tax debt help questions, need Chicago business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office toll free at 1-855-743-5765 or locally in Chicago or Indiana at 1-708-529-6604. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.