Net Operating Losses
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).
Questions?
37