Net Operating Loss

Lesson:

A net operating loss (NOL) occurs when a business’s allowable tax deductions for the year exceed its gross income. In other words, the business has a tax loss rather than taxable income. The tax rules let you use that loss to offset taxable income in other years, subject to limits.

As of 2020, carrybacks (applying losses against previous years' profits) are generally not permitted.

Carryforwards (applying losses against future years' profits) are allowed with no time limit. We refer to the future tax benefits as deferred tax assets, and they are kept on the balance sheet as an asset.

You've just been hired as a CFO and are trying to make sense of the firm's financials.

You've been briefed with the following facts:

  • The firm wants to use the as much of its deferred tax assets as possible this year.
  • The firm has deferred tax assets (DTA) equal to $494.00.
  • The firm's tax rate is 13%.
  • The firm earned a profit of $3,792.40 this year.
What journal entries should be made this year when applying the deferred tax assets?

Answer:

  • Tax Payment Journal Entries
    Income tax expense     $493.01    
         Deferred tax asset     $394.41    
         Income tax payable     $98.60    

Explanation:

  1. First, we need to figure this years tax obligation.
    TAX OBLIGATION = TAX RATE * PROFIT
  2. Now let's plug in the numbers we were given.
    TAX OBLIGATION = 13% * $3,792.40
  3. Let's do the math.
    TAX OBLIGATION = $493.01
  4. The tax code says that only 80% of the tax obligation can be satisfied with deferred tax assets.
    EIGHTY PERCENT OF TAX OBLIGATION = 80% * $493.01
  5. And let's do the math out.
    EIGHTY PERCENT OF TAX OBLIGATION = $394.41
  6. So we have $494.00 of deferred tax assets to work with, and we can use up to $394.41 of deferred tax assets this year.
  7. We're only able to use the lesser of our available deferred tax assets and the 80% of this year's obligation.
    DEFERRED TAX ASSETS TO APPLY = $394.41
  8. Now we need to figure out how much cash will need to be spent above and beyond the deferred tax assets that we're using.
    ADDITONAL TAX PAYMENT = TAX OBLIGATION - DEFERRED TAX ASSETS TO APPLY
  9. The last calculation is to figure out how much cash will need to be spent above and beyond the deferred tax assets that we're using.
    ADDITONAL TAX PAYMENT = $493.01 - $394.41
  10. And here we see how much money will have to be spent on taxes in addition to deferred tax assets.
    ADDITONAL TAX PAYMENT = $98.60
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