Today's mini episode is about Net Operating Losses, which is a tax term, and how they can and should be taken into consideration in a divorce negotiation.
During the marriage, sometimes a spouse is involved in his or her own business endeavors. They're not just a salaried employee, but they are involved in some sort of investment project, or they have their own business that they're running, or whatever, as a result of which – and let’s say, their investment or their business does not go well in a given year, and they lose money in a given year, so the money that they make, the taxable income, is under the amount of tax deductions and legitimate business expenses that they can report – so that they have an operating loss for the year. They are not running a profit.
When that happens, obviously, the other spouse is not thrilled because it typically means that money has been lost. But there is some value to the spouses if they're filing joint taxes in a Net Operating Loss because the ability to report a Net Operating Loss on your tax returns will reduce your taxable income.
The biggest distinction and red flag that I want to throw up for you is that reducing your taxable income is not the same as reducing your taxes. The thing you want to keep in mind there is that—Let's say that you had a, your family has taxable income of $100,000, but your spouse had a Net Operating Loss of $10,000. And then let's say that without that Net Operating Loss, you would owe taxes of $25,000 on your $100,000 of income. So, when you have a Net Operating Loss of $10,000, that does not mean that your taxes go from $25,000 down to $15,000. That would be a tax credit, and that's really valuable. That's not what a Net Operating Loss is.
Net Operating Loss is – basically, if it's $10,000 – it would take your taxable income, the $100,000 in my example, from $100,000 down to $90,000. And then you would owe – you know, instead of $25,000 of taxes on $100,000 of income, well, maybe you owe $22,500 of taxes on $90,000 of income.
The quick way to assess the value of a Net Operating Loss is to look at the amount of the loss multiplied by your effective tax rate. And if this all sound like Greek to you, that's normal. Just be sure to consult with your accountant, your CPA on the subject and they will be able to clarify it for you.
But I want to flag for you that business losses can be valuable as a tax asset but they are – they do not pay for themselves as a tax asset, so that's something that people often confuse.
Anyway, this was our episode on Net Operating Losses in a divorce. I hope it was helpful for you.