Net Operating Losses Chapter 2 pp. 39-67 2015 National Income Tax Workbook™

Net Operating LossesChapter 2 pp. 39-67

2015 National IncomeTax Workbook™

Net Operating Lossespp. 39-67

NOL deductions allow the tax-payer to carry net business loss, after limitations, back 2,3,5, or 10 years, and forward up to 20 years.

Complexity arises due to I.R.C. § 172, which removes several other tax benefits before NOL deduc-tions can be calculated.

Steps for NOL Deductionp. 40

Determine Eligibility Compute the NOL Distribute the NOL to carryback

and carryforward years Recalculate taxes in the carry-

back years and calculate taxes in the carryforward years

Steps for NOL Deductionp. 40

Practitioner Note▪ NOL rules for individuals also

apply to estates and trusts.▪ See I.R.C.§ 642(h)(1),

Treas.Reg.§ 1.642(h)-2(b), and Treas.Reg.§ 1.642(h)-2(a) for application of estate/trust NOL to beneficiaries.

Determine Eligibilityp. 40

Individuals and C corporations may claim their own NOLs.

Partnerships and S corporations, and LLCs taxed as partnerships or S corpora-tions, generally cannot claim NOL deduc-tions.

Partners/members/shareholders use their separate shares of the business income and deductions to compute individual NOLs.

Compute the NOL pp. 40-42

Net taxable income must be negative, and must be modified by removing deductions not allowed for computing the NOL.▪ Generally, only business losses can be

carried from one year to another.▪ Items carried to another tax year under an-

other carryover rule are excluded from the NOL calculation.


The following are excluded from NOL by addition back to negative taxable income:▪ Dependent and personal exemption deductions▪ Nonbusiness deductions in excess of nonbusi-

ness income▪ Capital losses in excess of capital gains▪ 50% of the gain from qualified small business

stock▪ NOL deductions carried from another year▪ I.R.C. § 199 domestic production activities de-

ductions


Example 2.1▪ Nonbusiness deductions in excess of non-

business income by more than negative taxable income remove NOL.

Example 2.2▪ Personal exemption deductions added

back to negative taxable income to com-pute NOL.


An NOL that is carried to a base year under the I.R.C. § 1301 income averag-ing rules is allowed in full when comput-ing the taxable income for the base year.

However, any NOL that may provide a tax benefit in another tax year must be added back to calculate base year tax-able income for any subsequent years’ income averaging calculations.


Deductions that are suspended by other rules get no special treatment under the NOL rules in the year they are suspended.

Schedule A-NOL (Form 1045) is an excellent worksheet for computing the NOL.

Distribute the NOL pp. 42-49

Distributing the NOL is complicated by two rules:▪ There are several different carryback peri-

ods depending on the source of the NOL.▪ The amount of the NOL that is absorbed in

a carryback or carryforward year is the modified taxable income for that year, not the taxable income.


Default Carryback Period (2 years)▪ Generally a NOL can be carried back to the

2 tax years immediately preceding the loss year. If it is not fully absorbed in those years, the remainder can be carried for-ward for up to 20 years after the loss year.

▪ See I.R.C. § 172(b)(1)(A)(i) and I.R.C. § 172(b)(1)(A)(ii).


Casualty, Theft, Small Business Disaster Losses (3 years)▪ The following eligible losses garner a 3

year carryback period: individual NOL aris-ing from casualty or theft losses, small business NOLs due to “federally declared disasters.”

▪ See I.R.C. § 172(b)(1)(E)(iii).


Farming Loss (5 years)▪ Taxpayers who have an NOL from a farm-

ing business can carry that NOL back 5 years and then forward up to 20 years.

▪ See I.R.C. § 172(b)(1)(F), 172(h)(1)(A) and 263A(e)(4); Treas. Reg. § 1.263A-4(a)(4).


Specified Liability Losses (10 years)▪ A specified liability loss is the portion of an

NOL attributable to a product liability loss; to certain reclamation, remediation, or shutdown expenses; or to workers’ com-pensation payments.

▪ See I.R.C. § 172(b)(1)(C), 172(f)(1)(A), 162, 165.


Taxpayers who decide to forgo the 2-year carryback or any of the longer carryback pe-riods must include a statement with the origi-nal return for the loss year for which they are waiving the carryback period.

If a taxpayer does not elect out of the carry-back, the NOL is absorbed by the carryback years whether or not the NOL deduction is claimed for those years.


The amount of an NOL that is absorbed by a year to which the loss is carried is equal to that year’s modified taxable income.

Schedule B—NOL Carryover (Form 1045) calculates how much of an NOL is absorbed in a carryback or carryforward year and the amount that is still available to carry to the next year.

Calculate Taxes in Carryback and Carry-forward Years

p. 50

NOL deductions carried back re-duces AGI for the carryback year, which may affect other deductions, which must then be recalculated. These changes are reported on Form 1045, or an amended return.

In carryforward years the deduction is claimed as negative “Other in-come” on line 21 of a from 1040.

Calculate Taxes in Carryback and Carry-forward Years

p. 50

Form 1045 requesting a refund resulting from an NOL must be filed no later than the end of the tax year following the year the NOL occurred.

However it cannot be filed be-fore the return is filed for the year the NOL occurred.

NOL Carried Between Joint and Separate Returns

pp. 50-52

If a taxpayer’s filing status is dif-ferent in the loss year and in any of the carryback or carry forward years (due to filing changes, divorce, or remar-riage), allocations of the NOL may be required.

Allocation of NOLs from a Joint Return pp. 50-51

An NOL must be allocated if it is created in a year a married couple files a MFJ return and is carried to a year for which the same spouses did not file MFJ.

The joint NOL is allocated between the spouses on a pro rata basis, using the NOLs that would have been generated by each spouse individually if they had filed MFS for the NOL year.

Allocation of Income and De-ductions pp. 51-52

Income/deductions must be allocated be-tween spouses if an NOL from a year they were not married is carried to a year they file a MFJ return.

If an NOL is carried from a year a married couple filed a MFJ return to a year after one spouse died and the surviving spouse files a single return, the NOL must be allocated be-tween the two spouses. The surviving spouse can deduct only the NOL allocated to them on their single return.


Divorced taxpayers carrying a NOL from a year after the di-vorce back to a MFJ return year must allocate the income, de-ductions, and tax payments on the MFJ return between the ex-spouses.


Remarried taxpayers carrying a NOL from a year after the remarriage back to a MFJ return year with a previous spouse must allocate the NOL first be-tween the taxpayer and their current spouse.

The carryback then can be used to off-set only the taxpayer’s share of the tax-able income on the MFJ return with the first spouse.

Separate Returns may Reduce Tax Liabil-ity

p. 52

Filing MFS during NOL years can be advantageous in years when joint income is lower than average annual income.

Example 2.12▪ Filing MFS allows for a NOL

deduction and significant tax savings.

Special Issues in NOL Calcu-lations p. 53

It can be difficult to decide whether a particular gain or loss is part of a NOL.▪ Passive activity losses▪ Sales of assets used in a trade

or business▪ Gains and losses from partner-

ships and S corporations

Passive Activity Losses p. 53

Passive activity loss rules are applied before NOL rules.

Only losses that are currently deductible un-der the passive loss rules can become a part of an NOL. A loss that is suspended by the passive loss rules becomes part of an NOL computation in the year it comes out of sus-pension.

In that year, it is characterized as a business or nonbusiness loss according to its origin.

Sale of Assets Used in a Trade or Business p. 53

Gain or loss from the sale of an asset used in a trade or busi-ness is a business gain or loss for the NOL calculation.

S Corporations and Partner-ships p. 53

S corps and partnerships can-not carry business losses to other tax years by deducting NOLs.

Losses flow to shareholders or partners in loss years to be part of individual NOLs.

Making Optimal Use of an NOL Deduction pp. 54-65

Tax benefits may waste NOLs.▪ May reduce NOL in a loss year

but not reduce taxable income.▪ In carryback or carryforward

years, other tax benefits may reduce the NOL to be carried to subsequent years but not re-duce taxable income.

NOL Planning: Case Studypp. 54-60

Barb & Guy Wire:▪ See Figure 2.9 for income/deductions▪ See Figure 2.10 for NOL calculation on Form

1045

Key points:▪ Treating excess nonbusiness deductions▪ Shifting nonbusiness income to loss year▪ Treating excess nonbusiness capital losses

Waving Carryback May Re-duce Tax Liability p. 60

NOL deductions can be more useful car-ried forward because of higher tax rates imposed in high-income years.

Capital losses in carryback or carryfor-ward years may keep the taxpayer from realizing the full benefit of the NOL deduc-tion in those years.

The NOL deduction may cause the loss of a tax credit that cannot be carried beyond the carryback or carryforward year.

Present Value of Carryforwardpp. 60-65

The present value of tax sav-ings must be computed to properly compare carrying a NOL back and carrying it for-ward.

See Example 2.17

Control Timing of NOLp. 65

The years in which the NOL gener-ates the greatest benefit are those that have the highest taxable income (and are therefore in the highest marginal bracket) and those with little long-term capital gain or tax credits that will waste the NOL.

Use Up NOL Before It Expiresp. 65

If the time for using an NOL is about to expire, accelerating in-come to absorb the full loss will reduce total taxes.

Shifting income to make use of an NOL that would otherwise expire makes the shifted in-come effectively tax-free.

Appendix pp. 65-67

Included in the appendix are worksheets for calculating:▪ Business and nonbusiness capi-

tal gains and losses.▪ Nonbusiness deductions and in-

come (required for Schedule A Form 1045).

Questions?

37

Net Operating Losses Chapter 2 pp. 39-67 2015 National Income Tax Workbook™

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