Introduction
Experiencing business losses can be daunting, especially when the losses are so substantial that the business ceases operations. However, the U.S. tax code provides relief mechanisms, one of which is Terminal-Loss Relief. Understanding how to claim terminal-loss relief can help mitigate financial losses and provide some recovery from failed ventures. In this guide, I will explain terminal-loss relief in detail, offering examples, calculations, and a practical approach to filing claims.
Table of Contents
What Is Terminal-Loss Relief?
Terminal-loss relief allows businesses that cease operations to claim tax relief for their final period of trading losses. In the U.S., this applies mainly to sole proprietorships, partnerships, and corporations that dissolve. Losses can be used to reduce tax liabilities for past years, providing much-needed financial recovery.
Eligibility for Terminal-Loss Relief
To qualify for terminal-loss relief, a business must:
- Have ceased trading permanently
- Incurred a net operating loss (NOL) in the final year
- Be able to apply losses against prior years’ taxable income
- Follow IRS regulations on NOL carryback and carryforward rules
How Terminal-Loss Relief Works
The IRS allows businesses to carry back NOLs to previous profitable years or carry them forward. The Tax Cuts and Jobs Act (TCJA) of 2017 modified these rules significantly.
Pre-2017 Rules
Before 2017, businesses could carry back NOLs for two years and carry them forward for 20 years. This meant a business with losses in its final year could offset taxable income from the prior two years, reducing tax liabilities.
Post-TCJA Rules
The TCJA eliminated the two-year carryback for most businesses but allowed indefinite carryforwards. However, NOL deductions are now limited to 80% of taxable income in any given year.
COVID-19 Adjustments
The CARES Act temporarily restored the NOL carryback for five years for losses incurred in 2018, 2019, and 2020. This allowed businesses affected by the pandemic to claim refunds on previously paid taxes.
Calculating Terminal-Loss Relief
To determine the relief amount, businesses must compute their final-year NOL and apply it against prior years’ taxable income.
Example: A business ceases operations in 2023 with a final-year net operating loss of $200,000. It had the following taxable incomes in previous years:
- 2022: $50,000
- 2021: $80,000
- 2020: $90,000
If the business elects to carry back losses, it can offset past incomes as follows:
Step 1: Apply NOL to the most recent year (2022): Remaining loss: 200,000 - 50,000 = 150,000
Step 2: Apply to 2021: Remaining loss: 150,000 - 80,000 = 70,000
Step 3: Apply to 2020: Remaining loss: 70,000 - 70,000 = 0
By carrying back losses, the business effectively eliminates taxable income for three years, triggering tax refunds for those years.
Terminal-Loss Relief vs. Capital Allowances
| Criteria | Terminal-Loss Relief | Capital Allowances |
|---|---|---|
| Purpose | Offset operating losses | Deduct cost of assets |
| Applicability | Upon business closure | Ongoing operations |
| Claim Type | NOL deduction | Depreciation claims |
| Timing | Final tax year | Annually |
Filing a Claim
To claim terminal-loss relief, businesses must file IRS Form 1045 (for individuals) or Form 1139 (for corporations). Supporting documentation includes:
- Final tax return
- Profit and loss statements
- Balance sheets
- Previous tax returns
Conclusion
Understanding terminal-loss relief is essential for financial recovery after business closure. By applying NOLs strategically, businesses can reclaim past taxes, reducing financial strain. Careful planning ensures that losses are used efficiently, maximizing tax benefits.
