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

Net Operating Losses pp. 39-67
 NOL deductions allow the taxpayer 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 deductions can be calculated.

Steps for NOL Deduction p. 40
 Determine Eligibility
 Compute the NOL
 Distribute the NOL to carryback and carryforward years
 Recalculate taxes in the carryback years and calculate taxes in the carryforward years

Steps for NOL Deduction p. 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 Eligibility p. 40
 Individuals and C corporations may claim their own NOLs.
 Partnerships and S corporations, and
LLCs taxed as partnerships or S corporations, generally cannot claim
NOL deductions.
 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 another carryover rule are excluded from the NOL calculation.

Compute the NOL pp. 40-42
 The following are excluded from NOL by addition back to negative taxable income:
▪ Dependent and personal exemption deductions
▪ Nonbusiness deductions in excess of nonbusiness 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 deductions

Compute the NOL pp. 40-42
 Example 2.1
▪ Nonbusiness deductions in excess of nonbusiness income by more than negative taxable income remove NOL.
 Example 2.2
▪ Personal exemption deductions added back to negative taxable income to compute NOL.

Compute the NOL pp. 40-42
 An NOL that is carried to a base year under the I.R.C. § 1301 income averaging rules is allowed in full when computing 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 taxable income for any subsequent years’ income averaging calculations.

Compute the NOL pp. 40-42
 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 periods 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.

Distribute the NOL pp. 42-49
 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 forward 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).

Distribute the NOL pp. 42-49
 Casualty, Theft, Small Business Disaster
Losses (3 years)
▪ The following eligible losses garner a 3 year carryback period: individual NOL arising from casualty or theft losses, small business NOLs due to “federally declared disasters.”
▪ See I.R.C. § 172(b)(1)(E)(iii).

Distribute the NOL pp. 42-49
 Farming Loss (5 years)
▪ Taxpayers who have an NOL from a farming 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).

Distribute the NOL pp. 42-49
 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’ compensation payments.
▪ See I.R.C. § 172(b)(1)(C), 172(f)(1)(A),
162, 165.

Distribute the NOL pp. 42-49
 Taxpayers who decide to forgo the 2-year carryback or any of the longer carryback periods must include a statement with the original return for the loss year for which they are waiving the carryback period.
 If a taxpayer does not elect out of the carryback, the NOL is absorbed by the carryback years whether or not the NOL deduction is claimed for those years.

Distribute the NOL pp. 42-49
 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 Carryforward Years p. 50
 NOL deductions carried back reduces
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 income” on line 21 of a from 1040.

Calculate Taxes in Carryback and Carryforward 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 before 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 different in the loss year and in any of the carryback or carry forward years (due to filing changes, divorce, or remarriage), 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
Deductions pp. 51-52
 Income/deductions must be allocated between 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 between the two spouses. The surviving spouse can deduct only the NOL allocated to them on their single return.

Allocation of Income and
Deductions pp. 51-52
 Divorced taxpayers carrying a
NOL from a year after the divorce back to a MFJ return year must allocate the income, deductions, and tax payments on the MFJ return between the ex-spouses.

Allocation of Income and
Deductions pp. 51-52
 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 between the taxpayer and their current spouse.
 The carryback then can be used to offset only the taxpayer’s share of the taxable income on the MFJ return with the first spouse.

Separate Returns may Reduce
Tax Liability 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
Calculations 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 partnerships and S corporations

Passive Activity Losses p. 53
 Passive activity loss rules are applied before NOL rules.
 Only losses that are currently deductible under 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 suspension.
 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 business is a business gain or loss for the NOL calculation.

S Corporations and
Partnerships p. 53
 S corps and partnerships cannot 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 reduce taxable income.

NOL Planning: Case Study pp. 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
Reduce Tax Liability p. 60
 NOL deductions can be more useful carried forward because of higher tax rates imposed in high-income years.
 Capital losses in carryback or carryforward years may keep the taxpayer from realizing the full benefit of the NOL deduction 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 Carryforward pp. 60-65
 The present value of tax savings must be computed to properly compare carrying a
NOL back and carrying it forward.
 See Example 2.17

Control Timing of NOL p. 65
 The years in which the NOL generates 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 Expires p. 65
 If the time for using an NOL is about to expire, accelerating income to absorb the full loss will reduce total taxes.
 Shifting income to make use of an NOL that would otherwise expire makes the shifted income effectively tax-free.

Appendix pp. 65-67
 Included in the appendix are worksheets for calculating:
▪ Business and nonbusiness capital gains and losses.
▪ Nonbusiness deductions and income (required for Schedule A
Form 1045).

37