final copyright 2015 lgutef net operating losses...

© 2015 Land Grant University Tax Education Foundation, Inc. 39

NET OPERATING LOSSES

2Steps for NOL Deduction � � � � � � 40NOL Carried between Joint

and Separate Returns � � � � � � 50Special Issues in

NOL Calculations � � � � � � � � � � 53

Making Optimal Use of an NOL Deduction � � � � � � � � � 54

Appendix � � � � � � � � � � � � � � � � � � 65

Learning Objectives

After completing this session, participants will be able to perform the following job-related actions:

✔✔ Determine which taxpayers can and cannot carry a net operating loss (NOL) to other tax years

✔✔ Understand how taxable income is adjusted to compute an NOL

✔✔ Compute the amount of NOL that is absorbed by an intervening year

✔✔ Claim a refund resulting from carrying an NOL back to prior tax years

✔✔ Explain the limits on deducting NOLs carried between MFJ returns and returns that are not MFJ returns of the same spouses

✔✔ Optimize the use of NOLs by shifting income or deductions between tax years

✔✔ Make the best use of NOLs by choosing when to forgo the NOL carryback

Introduction

A net operating loss (NOL) deduction can offset the sometimes harsh consequences of the annual accounting period used for income taxes. NOL deductions allow taxpayers to carry a tax year’s net business loss (after loss deduction limitations such as the at-risk rules, passive loss rules, and hobby loss rules are applied) back 2, 3, 5, or 10 years, and forward up to 20 years, to offset tax-able income in those years.

The principle of NOLs is simple, but actual computation of NOL deductions can be com-plex. Complexity arises because the provisions of I.R.C. § 172 remove several other tax benefits before an NOL deduction is calculated. Those benefits are removed by modifying income and deductions in all affected years:

FINAL COPYRIGHT 2015 LGUTEF

40 INTRODUCTION

their own NOLs. Partnerships and S corpora-tions, and LLCs that are taxed as partnerships or S corporations, generally cannot claim an NOL deduction. Instead, the partners, members, or shareholders use their separate shares of the part-nership, LLC, or S corporation business income and deductions to figure their individual NOLs.

Step 2: Compute the NOL

Negative taxable income for the NOL year is modified by removing deductions that are not allowed in computing the NOL.

Net Taxable Income Must Be Negative

If taxable income for the year is not negative, the taxpayer does not have an NOL for that year� However, a taxpayer with negative taxable income will not necessarily have an NOL for that year, as explained in the following discussion�

Items Not Included in NOLSeveral items that are included in the calculation of taxable income are not included in the NOL calculation. These usually are excluded from the NOL computation for one of two reasons.

■■ Generally, only business losses can be car-ried from one year to another; therefore, with a few exceptions, nonbusiness deduc-tions in excess of nonbusiness income are not included in the NOL.

STEPS FOR NOL DEDUCTION Computing an NOL and claiming the NOL deduction requires four successive steps�

The process of computing an NOL for an indi-vidual taxpayer and claiming the NOL deduction must be carried out in the following four steps.

1. Determine eligibility2. Compute the NOL3. Distribute the NOL to carryback and carry-

forward years4. Recalculate taxes in the carryback years and

calculate taxes in the carryforward years

Estate and Trusts

The NOL rules for individuals also apply to estates and trusts� If an estate or trust has an NOL car-ryover from its final year, the beneficiaries of the estate or trust continue to use the carryover NOL until it is absorbed or until the carryforward period expires [I�R�C� § 642(h)(1)]� However, if the last year of the carryover period is the last year of the estate or trust, the remaining NOL is an excess deduction of the estate or trust that is distributed to the beneficiaries who succeed to the property of the estate or trust [Treas� Reg� § 1�642(h)-2(b)]� The excess deduction allocated to a beneficiary can be deducted only in the year it is distributed� If the deduction (when added to other deduc-tions) exceeds the beneficiary’s gross income, the excess cannot be carried over to subsequent years [Treas� Reg� § 1�642(h)-2(a)]�

Step 1: Determine Eligibility

Generally, taxpayers are allowed to reduce their own income with their own losses from other years. Individuals and C corporations may claim

1. Deductions for the NOL year are modified to determine the NOL that can be carried to other years.

2. Taxable income is modified in the years to which the loss is carried to determine how much of the NOL is absorbed.

A refund resulting from carrying NOLs back to prior years can be claimed by filing an amended

return for each carryback year or by filing Form 1045, Application for Tentative Refund, for all carryback years. In the carryforward years the NOL deduction is claimed as negative “Other income” on line 21 of Form 1040. The deadlines for filing these forms are discussed under the heading “Step 4: Calculate Taxes in Carryback and Carryforward Years” later in this chapter.


Step 2: Compute the NOL 41

2

■■ Items that carry to another tax year under another carryover rule—such as capital loss carryovers—are excluded from the NOL cal-culation to avoid duplication.

The following items are excluded from the NOL by adding them back to the taxpayer’s neg-ative taxable income [I.R.C. § 172(d)]:

1. Dependent and personal exemption deductions

Schedule A (Form 1045) Calculation

Form 1045 includes Schedule A as a worksheet for the calculation of an NOL� Instead of starting with negative taxable income and then adding back the personal and dependent exemptions deduction, Schedule A (Form 1045) begins with the taxpayer’s income before the personal and dependent exemptions deduction is subtracted� Consequently, it is not added back on Schedule A (Form 1045) to compute the NOL�

2. Nonbusiness deductions in excess of non-business income

3. Capital losses in excess of capital gains 4. The exclusion of 50% of the gain from I.R.C.

§ 1202 stock (qualified small business stock) 5. An NOL deduction carried from another

year 6. The I.R.C. § 199 domestic production activi-

ties deduction

If the sum of the items that are added back is greater than the negative taxable income, there is no NOL for the year.

Example 2.1 Adding Back Nonbusiness Deductions

Paige Turner’s taxable income for 2015 before deducting exemptions is a negative $10,000 due to both business losses and nonbusiness deduc-tions. If her nonbusiness deductions exceed her nonbusiness income by $6,000, she must add that $6,000 back to her negative $10,000 taxable income, which reduces her NOL to $4,000.

If Paige’s nonbusiness deductions exceed her nonbusiness income by more than her $10,000 negative taxable income, she does not have an NOL.

Business Income and DeductionsIncome and deductions are business income and deductions if they arise from a trade or business. This includes gain or loss from the disposition of both real property used in a trade or business and depreciable property used in a trade or business [I.R.C. § 172(d)(4)(A)]. Employment is treated as a trade or business, which means wages are busi-ness income and deductible employee expenses are business deductions.

The exception to the business connection requirement is that deductions attributable to casualty and theft losses from property held for personal use or for investment are treated as busi-ness losses for the NOL calculation even though they are not connected with a trade or business [I.R.C. § 172(d)(4)(C)].

Effect of Business or Nonbusiness Classification

Classifying ordinary income and capital gain as nonbusiness is advantageous to the taxpayer because it reduces the amount of nonbusiness deductions that must be added back to compute the NOL� Similarly, classifying deductions and capital losses as business is advantageous to the taxpayer�

Example 2.2 Business and Nonbusiness Income and Deductions

Neil Down, who is not married and does not itemize deductions, realized a $10,000 loss from his sole-proprietor auto parts business in 2015. However, due to other income and deductions, as shown in Figure 2.1, his taxable income for 2015 was negative $13,800.

FIGURE 2.1 Neil Down’s 2015 Taxable Income

Income or Deduction Amount

Business loss ($10,000)Wage income 6,000Investment income 500Adjusted gross income ($3,500)Personal exemption deduction (4,000)Standard deduction (6,300)Taxable income ($13,800)


42 STEPS FOR NOL DEDUCTION

In calculating his NOL, Neil is not allowed to deduct his personal exemption deduction. He can deduct $500 of his standard deduction because he has $500 of nonbusiness (investment) income. Consequently, Neil adds back his $4,000 per-sonal exemption deduction and $5,800 ($6,300 – $500) of his standard deduction to his negative $13,800 taxable income to compute his $4,000 (–$13,800 + $4,000 + $5,800) NOL.

Other Ways to Look at the NOL

Note that the $4,000 NOL equals the sum of Neil’s negative $3,500 AGI and the $500 portion of his standard deduction that is allowed by his $500 investment income� His NOL could also be viewed as his $10,000 business loss reduced by his $6,000 wage income�

Farm and Fishing Income AveragingAn 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—even if the deductions exceed gross income and the result is negative taxable income. However, any NOL that may provide a tax ben-efit in another tax year must be added back to calculate base year taxable income [Treas. Reg. § 1.1301-1(d)(2)(i)(A)] for any subsequent years’ income averaging calculations. This prevents taxpayers from getting a double benefit from an NOL.

Farm Income Averaging Election Example

See pages 371–375 of the 2009 National Income Tax Workbook for an example of the interaction of the NOL rules and the farm income averaging rules�

Suspended DeductionsDeductions that are suspended by rules such as the limit on charitable contribution deductions, passive activity losses, amount at risk, or basis in a pass-through entity get no special treatment under the NOL rules in the year they are sus-pended. Because they are not used to compute taxable income in the year they are suspended, they are not added back to compute the NOL for that year. If they are allowed as a deduction in a later year, they reduce taxable income for that year and are subject to the rules for including deductions in the NOL in that year.

Schedule A (Form 1045)Schedule A—NOL (Form 1045) is an excellent worksheet for computing the NOL, not only for filing Form 1045 but also for filing amended returns for the carryback years.

To aid in the completion of Schedule A—NOL (Form 1045), a set of four worksheets is included in the appendix of this chapter. They are filled in for the facts in the NOL-planning case study later in this chapter. NOL Worksheet 1 computes the nonbusiness and business capital losses that are entered on lines 2 and 11 of Schedule A (Form 1045) respectively. NOL Worksheet 2 computes the nonbusiness and business capital gains that are reported on lines 3 and 12 of Schedule A (Form 1045) respectively. NOL Worksheet 3 computes the nonbusiness deductions that are entered on line 6 of Schedule A (Form 1045), and NOL Worksheet 4 computes the nonbusiness income that is entered on line 7 of Schedule A (Form 1045).

Step 3: Distribute the NOL

The NOL calculated in Step 2 is then distributed among the years eligible for the NOL deduction from the loss year. Two separate rules make this step a bit complicated.

1. There are several different carryback periods, depending on the source of the NOL.

2. The amount of the NOL that is absorbed in a carryback or carryforward year is the modi-fied taxable income for that carryback or car-ryforward year—not the taxable income of the carryback or carryforward year.


Step 3: Distribute the NOL 43

2

Modifications to taxable income in carry-back and carryforward years are explained later in this chapter, but they include adding back the personal and dependent exemption deductions before the NOL deduction is taken. Therefore, the amount of the NOL that is absorbed in a carryback or carryover year is greater than that year’s taxable income without regard to the NOL. In other words, taxpayers generally do not fully benefit from the NOL deduction.

Taxpayers can elect to forgo the carryback period and carry the NOL forward only. This election must be made on the timely filed original return for the NOL year or on an amended return for the NOL year that is filed within 6 months of the due date of the original return.

Intervening Years Open for Audit

If the taxpayer does not elect to forgo the carry-back, the income and deductions that affect the amount of NOL absorbed in those years are sub-ject to audit until the statute of limitations has run for all of the years to which the NOL is carried [Springfield Railway Co. v. United States, 312 F�2d 754 (Ct� Cl� 1963)]�

Default Carryback Period (2 Years)Generally, an NOL can be carried back to the 2 tax years immediately before the loss year [I.R.C. § 172(b)(1)(A)(i)]. If it is not fully absorbed in those 2 years, the excess is carried forward for up to 20 years after the loss year [I.R.C. § 172(b)(1)(A)(ii)]. However, longer carryback periods are specified for NOLs that result from specific types of losses.

Excess NOL at End of 20-Year Carryforward Period

Any NOL that is not absorbed in the carryback and carryforward periods is lost� It cannot be deducted in any other tax year�

Casualty, Theft, and Small Business Disaster Losses (3 Years)The carryback period is 3 years for the fol-lowing eligible losses described in I.R.C. § 172(b)(1)(E)(ii):

1. An individual taxpayer’s NOL arising from casualty or theft losses

2. Small business NOLs “attributable to feder-ally declared disasters”

A small business for this rule is a partnership, corporation, or sole proprietorship that had aver-age annual gross receipts of $5 million or less for the 3-year period ending with the loss year [I.R.C. § 172(b)(1)(E)(iii)].

Losses are not eligible for this 3-year carry-back period if they are eligible for a 5-year carry-back as a farming loss. Those rules are discussed later in this section.

Farming Losses Attributable to Disasters

I�R�C� § 172(b)(1)(E)(ii)(III) includes NOLs from farming in the 3-year carryback if they are attrib-utable to federally declared disaster areas� Appar-ently, the purpose of this provision is to qualify such losses for the 3-year carryback even if the farming business does not meet the average gross receipts test for small businesses�

However, the flush sentence that follows I�R�C� § 172(b)(1)(E)(ii)(III) excludes farming losses that qualify for the 5-year carryback� The committee reports for the Taxpayer Relief Act of 1998, Pub� L� No� 105-227, state, “The three-year carryback period continues to apply to an NOL incurred in a Presidentially [Editor’s note: “Presidentially” was replaced with “federally” by the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, Pub� L� No� 110-343, Sec� 706(a)(2)(D)(v) Div C] declared disaster area if such NOL is not eligible for the five-year carryback period�”

Because all NOLs from farming that are attrib-utable to federally declared disaster areas are also farming losses that qualify for the 5-year car-ryback, it appears that no farming losses qualify for the 3-year carryback�



FIGURE 2.2 Cherry Pitt’s 2015 NOL with Standard Deduction

Income, Deduction, or Loss Amount

Business loss ($10,000)

Investment income 500

Adjusted gross income ($9,500)

Personal exemption deduction (4,000)

Standard deduction (6,300)

Taxable income ($19,800)

Add back personal exemption deduction 4,000

Add back excess standard deduction ($6,300 – $500) 5,800

NOL ($10,000)

Because Cherry’s taxable income and NOL are not affected by her $700 theft loss, no portion of her NOL is an eligible casualty loss, and none of her NOL is eligible for the 3-year carryback period. Cherry’s $10,000 NOL is eligible for the default 2-year carryback.

Example 2.4 Itemized Deduction of Casualty Loss

Cherry Pitt from Example 2.3 had a $50,000 theft loss instead of a $700 theft loss, so she itemized her deductions instead of claiming the standard deduction. Her negative $67,550 taxable income and $59,900 NOL for 2015 are calculated as shown in Figure 2.3.

FIGURE 2.3 Cherry Pitt’s 2015 NOL with Itemized Deductions


Business loss ($10,000)

Investment income 500

Adjusted gross income ( $9,500)

Personal exemption deduction ( 4,000)

Theft loss deduction [$50,000 – $100 floor – (10% x $0 AGI)] ( 49,900)

Other itemized deductions (4,500)


Add back personal exemption deduction 4,000

Add back excess nonbusiness deductions ($4,500 – $500) 4,000

NOL ($59,900)

Allocation to Different Carryback PeriodsIf an NOL results from eligible losses that qualify for the 3-year carryback as well as from losses that qualify only for the 2-year carryback, the NOL is allocated between the two types of losses and is treated as two separate NOLs [I.R.C. § 172(b)(1)(E)(iv)]. Neither I.R.C. § 172 nor the regulations under it explain how to allocate the NOL between eligible losses and other losses. IRS Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, and the instruc-tions for Form 1045, Application for a Tentative Refund, explain which losses are eligible for the 3-year carryback but do not explain how to allo-cate an NOL between the 3-year and the 2-year carryback. By contrast, I.R.C. § 172 gives explicit guidance for allocating an NOL to other types of losses that get special treatment, such as a speci-fied liability loss [I.R.C. § 172(f)] and a farming loss [I.R.C. § 172(i)(1)].

The general guidance given by I.R.C. § 172(b)(1)(E)(ii) for eligible losses is slightly dif-ferent for casualty and theft losses than for small business disaster losses.

Casualty and Theft LossesI.R.C. § 172(b)(1)(E)(ii)(I) includes “losses of property arising from fire, storm, shipwreck, or other casualty, or from theft” in the losses that can be carried back 3 years. Apparently that means an NOL can be allocated to the 3-year carryback to the extent of the casualty or theft loss that is deducted on the return for that tax year.

Example 2.3 Casualty Loss Not Claimed

Cherry Pitt, a single taxpayer, had a $700 theft loss from a Ponzi scheme in 2015, but her other itemized deductions were only $4,500, so she claimed the $6,300 standard deduction for single taxpayers. She had an NOL in 2015 arising from a $10,000 business loss. Her only income was $500 of investment income. Her $19,800 nega-tive taxable income and $10,000 NOL for 2015 are calculated as shown in Figure 2.2.



2

3. Allocate the NOL on a pro rata basis using the NOLs calculated in the first two methods as numerators and the total of those NOLs as the denominator.

Example 2.5 Small Business Disaster Loss

Doug A. Hole owns and operates a convenience store in Rural County, Anystate. In May 2015 there was widespread flooding, and the presi-dent declared the area a disaster area. The flood damaged Doug’s store, and his business realized a $70,000 loss because the store was closed for several weeks.

Doug’s wife, Phyl A. Hole, earned $20,000 as a substitute teacher and also operated an Internet retail business. That business realized a $30,000 loss in 2015 that was not related to the flood. The couple files a MFJ federal income tax return.Doug and Phyl’s $80,000 NOL is computed as shown in Figure 2.4.

FIGURE 2.4 Doug and Phyl Hole’s 2015 NOL


Wages $20,000

Taxable interest 5,500

Convenience store loss (70,000)

Internet business loss ( 30,000)


Standard deduction ( 12,600)

Personal exemption deductions ( 8,000)


Add back excess standard deduction ($12,600 – $5,500 nonbusiness income) 7,100

Add back personal exemption deductions

8,000

NOL ($80,000)

The possible NOL allocations to the 3-year carry-back under each of the three allocation methods are shown in Figure 2.5.

Because Cherry’s NOL includes the $49,900 theft loss deduction, that much of her NOL is eligible for the 3-year carryback. The remaining $10,000 of her NOL is eligible for the normal 2-year carryback.

Small Business Disaster LossesI.R.C. § 172(b)(1)(E)(ii)(II) uses different wording to define a small business NOL that is eligible for the 3-year carryback. It includes “net operating losses” that are attributable to federally declared disasters. By using the phrase “net operating losses” rather than “losses of property” (which is used to define an eligible casualty or theft loss), this provision apparently requires the taxpayer to compute the NOL that would result if only the income and deductions for business activi-ties in the federally declared disaster area were included.

Other Factors That Might Cause Losses

I�R�C� § 172(b)(1)(E)(ii)(II) may also require the tax-payer to sort out losses due to the disaster from losses due to other factors such as low prices for output or high prices for inputs� However, that sorting would be very difficult to administer� Because the IRS has not explicitly required that sorting, this discussion assumes it is not required�

After the NOL attributable to the feder-ally declared disaster is computed, at least three methods could be used to allocate the total NOL between the disaster NOL that is eligible for the 3-year carryback and the rest of the NOL that is eligible for the 2-year carryback. Three plausible methods are the following:

1. Allocate the NOL first to the 3-year carryback to the extent of the NOL that would result if only the income and deductions of small businesses that were affected by the disaster are taken into account. [This is the method used by I.R.C. § 172(h)(1) to allocate a tax-payer’s NOL to a farming loss.]

2. Allocate the NOL first to the 2-year carryback to the extent of the NOL that would result if only the businesses that were not affected by the disaster are taken into account.



Most Advantageous Method

The most advantageous method of allocating the NOL between the 3-year carryback and the 2-year carryback depends on the type and amount of income in the taxpayer’s carryback years�

If the type and amount of income are about the same in each of the carryback years and the NOL will be fully absorbed in 2 carryback years, the refund will be about the same whether the NOL is carried back 3 years or 2 years�

If the NOL will not be fully absorbed in 2 car-ryback years and the type and amount of income are about the same in each of the carryback years and the carryforward years, carrying the NOL back 3 years allows the taxpayer to realize more of the tax savings as a refund rather than as a reduction of future taxes� Therefore, allocating more to the 3-year carryback would be best for the taxpayer�

If the NOL carried to the third year before the loss year is partially wasted because of capital losses or a low tax bracket, it may be best for the taxpayer to allocate as much of the NOL as pos-sible to the 2-year carryback�

Priority in Carryback and Carryforward YearsThe portion of the NOL that is eligible for the 3-year carryback and the rest of the taxpayer’s NOL for the year are treated as separate NOLs for the carryback and carryforward rules [I.R.C. § 172(b)(1)(E)(iv) and (h)(2)]. The eligible loss for the 3-year carryback is taken into account after the rest of the NOL. That means the rest of the NOL will be used first in carryback and carryfor-ward years to which both NOLs are carried.

Example 2.6 Order for Applying NOLs

Using the first method of allocating the NOL in Example 2.5, Doug and Phyl carry $70,000 of their 2015 NOL back to 2012. The amount that is not absorbed in 2012 is carried to 2013. How-ever, before that remaining amount is applied to 2013, the $10,000 2-year carryback NOL from 2015 is applied to 2013. (The absorption rules are discussed later in this chapter.)

Ordering Rules Do Not Affect Deduction

The ordering rules have no effect on the timing and amount of the NOL deduction because the same total amount of the NOL will be absorbed by each carryback or carryforward year, and both NOLs can be carried forward for up to 20 years after the loss year�

Election to Waive the CarrybackBecause the 3-year carryback is substituted for the 2-year carryback, an election to forgo the NOL carryback applies to both the portion of the NOL that is carried back 2 years and the portion that is carried back 3 years. Taxpayers cannot choose to forgo the carryback for only the 3-year carryback or only the 2-year carryback.

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 [I.R.C. § 172(b)(1)(F)]. A farming business is a trade or business involv-ing cultivation of land; raising or harvesting of any agricultural or horticultural commodity; operating

FIGURE 2.5 Allocation of Doug and Phyl Hole’s 2015 NOL

Allocation MethodAllocated to 3-Year

CarrybackAllocated to 2-Year

Carryback

1� Allocate first $70,000 of NOL to the 3-year carryback $70,000 $10,000

2� Allocate first $30,000 of NOL to the 2-year carryback $50,000 $30,000

3� Allocate pro rata using NOL for each activity

$56,000 $24,000 [($70,000 ÷ $100,000) × $80,000 allocated to 3-year

carryback]



2

FIGURE 2.6 Sandy and Rocky Beach’s 2015 NOL


Wages $20,000

Taxable interest 5,500

Farming business loss ( 70,000)

Trucking business loss ( 30,000)


Standard deduction ( 12,600)

Personal exemption deductions ( 8,000 )


Add back excess standard deduction ($12,600 – $5,500 nonbusiness income) 7,100

Add back personal exemption deductions

8,000

NOL ($80,000)

Question 1.What is the NOL computed using only Sandy’s farm income and expenses?

Answer 1.It is the $70,000 farming business loss shown in Figure 2.6. Therefore, $70,000 of their total NOL is a farming loss that is eligible for the 5-year car-ryback, and the remaining $10,000 NOL is eli-gible for the 3-year carryback as a small business disaster loss.

Question 2.What is the NOL if Rocky’s wages were $35,000 instead of $20,000, a $15,000 increase in their income?

Answer 2.Their total NOL would be $65,000 ($80,000 – $15,000). The farming loss NOL eligible for the 5-year carryback is limited to the $65,000 total NOL, and there is no NOL eligible for the 3-year carryback.

Farm Loss Excluded from 3-year Carryback

The farm loss is excluded from the 3-year carry-back even though the farming business is a small business and the loss is attributable to a federally declared disaster [I�R�C� § 172(b)(1)(E)]�

a nursery or sod farm; and raising or harvesting of trees bearing fruit, nuts, or other crops, or of ornamental trees. Raising, shearing, feeding, car-ing for, training, and management of animals are also farming businesses. A farming business does not include contract harvesting of an agricultural or horticultural commodity grown or raised by someone else, or a business in which the taxpayer merely buys or sells plants or animals grown or raised by someone else [I.R.C. §§ 172(h)(1)(A) and 263A(e)(4); Treas. Reg. § 1.263A-4(a)(4)].

Allocation of NOL That Includes a Farming LossI.R.C. § 172(h)(1) defines a farming loss that is eligible for the 5-year carryback as the lesser of two amounts:

1. The NOL computed using only the income and deductions attributable to the farming business

2. The total NOL

Therefore, the taxpayer’s total NOL is allocated first to the farming loss and then to other losses.

Example 2.7 Farming Loss

Sandy Beach owns and operates a crop farm. Her husband, Rocky Beach, owns and operates a trucking business. In 2015 extensive and pro-longed flooding caused the president to declare their county a disaster area. Due to the flooding Sandy had a $70,000 loss from her farming busi-ness, and Rocky had a $30,000 loss from his truck-ing business. Rocky earned $20,000 in wages from a temporary job, and they earned $5,500 of taxable interest on certificates of deposit. They file a MFJ federal income tax return.

Sandy and Rocky Beach’s $80,000 NOL for 2015 is calculated as shown in Figure 2.6.



if the act or failure to act that caused the liabil-ity occurred at least 3 years before the beginning of the loss year and the taxpayer used accrual accounting during the periods the act or failure to act occurred [I.R.C. § 172(f)(1)(B)].

Some expenses that generally qualify are excluded from classification as specified liability losses. The excluded expenses are mining and solid waste disposal costs that the taxpayer elects to deduct under I.R.C. § 468(a)(1) and payments to the Nuclear Decommissioning Reserve Fund that the taxpayer elects to deduct under I.R.C. § 468A(a).

Taxpayers can elect to forgo the 10-year car-ryback and carry a specified liability loss back 2 years.

Election to Forgo Any CarrybackTaxpayers who decide to forgo the 2-year carry-back 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 car-ryback period under I.R.C. § 172(b)(3). The origi-nal return must be filed by the due date (including extensions) for that year. If the original return was filed by the unextended due date without the election, the taxpayer can make the election on an amended return that is filed within 6 months of the unextended due date.

If a taxpayer does not elect out of the carryback, the NOL is absorbed by the car-ryback years whether or not the NOL deduc-tion is claimed for those years.

Example 2.9 NOL Not Deducted

Eileen Forward had a $40,000 NOL in 2011. She did not elect to forgo the 2-year carryback, and she did not claim a refund of her 2009 and 2010 taxes that would have been reduced by the 2011 NOL. If she had claimed the NOL deduction for her 2009 and 2010 tax years, she would have received a $3,910 refund for 2009 and a $2,138 refund for 2010, and all of the NOL would have been absorbed.

Eileen took her 2015 tax information to Ardyth Accountant in March 2010. Ardyth looked at Eileen’s past returns and noticed that she had not claimed the refunds from carrying the 2011 NOL back to 2009 and 2010. Because it is too late to file an amended return for 2011, Eileen cannot claim the refunds for 2009 and

Election to Waive the 5-year CarrybackTaxpayers can elect to waive the 5-year carry-back [I.R.C. § 172(i)(3)]. If a taxpayer makes that election, the carryback period reverts to 2 years.

Example 2.8 Waiving the 5-Year Carryback

If Sandy and Rocky Beach from Example 2.7 elect to forgo the 5-year carryback of Sandy’s $70,000 farming loss, it may be carried back 2 years. The election to forgo the 5-year carryback of the farming loss and use the 2-year carryback period does not affect the 3-year carryback of the $10,000 small business disaster loss. Sandy and Rocky could also elect to forgo any carryback of their $80,000 NOL.

Specified Liability Losses (10 Years)Taxpayers can carry a specified liability loss back 10 years before the loss year [I.R.C. § 172(b)(1)(C)]. 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.

A product liability loss is an amount allowed as a deduction under I.R.C. § 162 or 165 that arose from the taxpayer’s liability for damage or loss of use of property or for physical injury or emo-tional harm to individuals because of a defect in a product manufactured, leased, or sold by the tax-payer. The injury, harm, or damage must occur after the taxpayer had completed manufacturing and installing the product and had relinquished possession of it. Expenses incurred in the investi-gation, settlement, or defense of claims of product liability are also included [I.R.C. § 172(f)(1)(A)].

Other specified liabilities are expenses incurred under a federal or state law requiring any of the following five actions:

1. Reclaiming land2. Decommissioning a nuclear power plant3. Dismantling a drilling platform4. Remediating environmental contamination5. Making a payment under a workers’ compen-

sation act

The deduction for any of these legally required expenses is a specified liability loss only



2

2010. However, her NOL is still absorbed by her 2009 and 2010 modified taxable income because she did not elect to forgo the carryback. There-fore, she has no 2011 NOL to carry forward to open tax years.

Recordkeeping

The burden is on the taxpayer to show the amount of NOL that is available to deduct in a carryfor-ward year� If a taxpayer did not deduct an NOL in a closed year, the taxpayer must still keep records of the NOL absorption to verify the NOL carried to each tax year�

NOL AbsorptionThe 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. Therefore, the amount that is carried to the second eligible year is the beginning NOL minus the first eligible year’s modified taxable income. The NOL carried to the third eligible year is the amount carried to the second year minus the second year’s modified taxable income. This process is repeated until the NOL is fully absorbed or until it is carried to the last eligible year. Schedule B—NOL Car-ryover (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.

Modifications of Taxable IncomeTaxable income is modified for purposes of the NOL absorption by adding back the following four items [I.R.C. § 172(d)(2)]:

1. Capital losses deducted in excess of capital gains

2. The partial exclusion of gain on qualified small business stock under I.R.C. § 1202

3. The domestic production activities deduction (DPAD) under I.R.C. § 199

4. The deduction for personal and dependent exemptions

The capital loss deduction, the I.R.C. § 1202 exclusion, and the DPAD are entered on lines 3, 4, and 5 of Schedule B (Form 1045).

Collateral Effect of Modifications The first three modifications to taxable income listed above increase AGI and therefore have a collateral effect on other income, exclusions, and deductions in the carryback or carryforward year.

Adjusted Gross IncomeAdding back capital losses in excess of capital gains, the partial exclusion of I.R.C. § 1202 gain, and the DPAD increases AGI and thus affects income, exclusions, and deductions that are cal-culated with reference to AGI. If a taxpayer has any of these three addbacks, the following items must be adjusted after these items are added back. The items in this list must be recalculated in the order listed, and, after each is recalculated, the newly modified AGI is used to compute the next item on the list.

The seven income, exclusion, and deduction items that are both affected by AGI and affect AGI are as follows:

1. The special allowance for passive activity losses from rental real estate activities

2. Taxable social security benefits3. IRA deductions4. Excludable savings bond interest5. The exclusion of amounts received under an

employer’s adoption assistance program6. The student loan interest deduction7. The tuition and fees deduction

These adjustments to AGI are entered on line 6 of Schedule B (Form 1045).

Itemized DeductionsIf the taxpayer itemized deductions for the intervening year, any itemized deductions that are based on AGI must be recalculated using the modified AGI. The adjustment to itemized deductions is computed on lines 11 through 38 of Schedule B (Form 1045) and is entered on line 7 of that schedule.

Farm and Fishing Income AveragingAny reduction or increase in taxable income for the election year or the base years under the



Allocation of NOLs from a Joint Return

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 [Treas. Reg. § 1.172-7(d)]. For example, if an NOL arises while the spouses are married and file MFJ, and it is carried to a year after they are divorced, a portion of the NOL may go to each of the former spouses. The joint NOL is allocated

NOL CARRIED BETWEEN JOINT AND SEPARATE RETURNS If the taxpayer’s filing status is not the same in the loss year and in all of the carryback or carryforward years, allocations may be required�

Taxpayers who file a MFJ return for at least one of the years involved in an NOL calculation and its carryback or carryforward period and file a MFS return, a MFJ return with a different spouse, or a not-married return for at least one of those years may need to allocate the NOL, income and deductions, or the modified taxable income between the spouses. However, income and deductions on a MFJ return do not have to be allocated when an NOL from a year the same couple filed MFS is carried to the return.

NOL occurred. However, Form 1045 cannot be filed before the income tax return is filed for the year the NOL occurred. For example, a calendar-year taxpayer with a 2015 NOL may file a Form 1045 application for refund after the 2015 income tax return is filed and before December 31, 2016.

Deadline for Form 1040XThe refund from carrying an NOL back can also be claimed by filing a Form 1040X for each of the carryback years. Form 1040X must be filed within 3 years of the due date (including exten-sions) for the loss-year tax return. For example, a calendar-year taxpayer with a 2015 NOL that is carried back to 2013 must file Form 1040X for 2013 by April 15, 2019, if he or she did not have an extension to file the 2015 tax return.

Election to Forgo the Carryback

As noted earlier in this chapter, the election to forgo the carryback must be made on the tax return for the year the NOL occurred or on an amended return for that year filed within 6 months (excluding extensions) of the due date for the original return� A calendar-year taxpayer has until October 17, 2016, to elect on an amended return to forgo the carryback of a 2015 NOL� If this deadline is not met, the taxpayer cannot forgo the carryback�

income averaging rules of I.R.C. § 1301(a) is dis-regarded in determining the modified taxable income for the tax year in which an NOL car-ryover is applied.

Step 4: Calculate Taxes in Carryback and Carryforward Years

If an NOL is carried back, it is claimed as a deduction that reduces taxable income and tax for the carryback year. The recalculation of tax in a carryback year is complicated because the NOL deduction reduces AGI, and that reduc-tion in AGI may affect itemized deductions and personal and dependent exemption deductions. Consequently, the affected deductions must be recalculated. The changes to the deductions are reported on Form 1045 or on an amended return (Form 1040X, Amended U.S. Individual Income Tax Return) for each carryback year.

In the carryforward years the deduction is claimed as negative “Other income” on line 21 of Form 1040.

Deadline for Form 1045If an NOL is carried back, the resulting refund can be requested by filing Form 1045 no later than the end of the tax year following the year the


Allocation of Income and Deductions 51

2

For example, a married couple filed MFJ returns each year until one spouse died. If the surviving spouse has an NOL in a later year, and that NOL is carried back to a MFJ return year, the income and deductions for the carryback year must be allocated between the spouses because the NOL can be used to offset only the surviving spouse’s income in the carryback year [Zeeman v. United States, 395 F.2d 861 (2d Cir. 1968)].

NOL Carryback after Spouse’s Death

See pages 313–329 of the 2006 National Income Tax Workbook for a comprehensive illustration of carrying an NOL from a year after the death of the taxpayer’s spouse to a MFJ return year�

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 him or her on his or her single return. The NOL allocated to the deceased spouse that remains at his or her death cannot be deducted.

If the taxpayers are divorced and one ex-spouse carries an NOL from a year after the divorce back to a MFJ return year, the income, deductions, and tax payments on the MFJ tax return must be allocated between the ex-spouses. Each may be eligible for a share of the income tax refund that results from the carryback even though the NOL is allocable to only one spouse. Each spouse’s percentage of the recomputed joint liability is calculated by dividing his or her recomputed separate liability by the total of their recomputed separate liabilities. Each spouse’s refund is limited to his or her share of the tax payments (including withholding) made for the carryback year, reduced by his or her share of the recomputed tax [Rev. Rul. 86-57, 1986-1 C.B. 362].

Two allocations may be required if a taxpayer is divorced and remarried. If an NOL occurs in a year when a MFJ return is filed with the sec-ond spouse, and it is to be carried back to a year when a MFJ return was filed with the first spouse, the NOL must first be allocated between the tax-payer and the second spouse. The carryback then

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.

■■ The husband’s percentage of the joint NOL is calculated by dividing the NOL he would have on a MFS return by the sum of the NOL he would have on a MFS return and the NOL his wife would have on a MFS return.

■■ The wife’s percentage of the joint NOL is calculated by dividing the NOL she would have on a MFS return by the sum of the NOL she would have on a MFS return and the NOL her husband would have on a MFS return.

If only one spouse has an individual NOL, all of the joint NOL is allocated to that spouse.

Example 2.10 Allocation of Joint NOL

Darrell and Sidney’s joint NOL is $10,000; Dar-rell’s individual NOL is $9,000, and Sidney’s individual NOL is $3,000. The separate NOLs total $12,000 ($9,000 + $3,000), and a portion of the $10,000 joint NOL is allocated to each spouse as follows:

■■ Darrell: ($9,000 ÷ $12,000) × $10,000 = $7,500

■■ Sidney: ($3,000 ÷ $12,000) × $10,000 = $2,500

Example 2.11 One Spouse Has an NOL

Sandy and Cindy’s joint NOL is $4,000; Sandy’s individual NOL is $7,000, and Cindy has no indi-vidual NOL. Sandy’s share of the joint NOL is the entire $4,000.

Allocation of Income and Deductions

Income and deductions must be allocated between spouses if an NOL that arose in a year they were not married is carried to a year they file a MFJ return [Rev. Rul. 65-140, 1965-1 C.B. 127].


52 NOL CARRIED BETWEEN JOINT AND SEPARATE RETURNS

to carry back. Therefore, their AGI for 2013 (the carryback year) is still $70,000. After deducting the $20,000 total of their $12,200 standard deduc-tion and $7,800 personal exemptions deduction, their taxable income for 2013 is $50,000, and their tax is $6,611.

If Tom and Mary file MFS returns for the loss year (2015), Mary’s taxable income is $11,200 ($21,500 AGI – $6,300 standard deduc-tion – $4,000 personal exemption deduction), her federal income tax is $1,223, and Tom has a $19,000 NOL to carry back. The NOL deduction reduces their 2013 joint AGI to $51,000 ($70,000 – $19,000), their joint taxable income to $31,000 ($51,000 – $12,200 – $7,800), and their income tax liability to $3,761. Therefore, the total tax due for the 2 years if they file MFS returns in 2015 is $4,984 ($1,223 + $3,761)—a savings of $1,627 ($6,611 – $4,984).

MFS Filing May Limit Deductions and Tax Credits

See the “Tax Benefits Limited by Income” chapter in this book for a discussion of deductions and tax credits limitations for MFS filers�

Separate Returns May Reduce Tax Liability

If one spouse has an NOL and the spouses’ joint income without the loss is lower than their aver-age annual income, it may be advantageous to file MFS returns in the NOL year. By filing MFS, the NOL can be carried to another tax year to reduce income in a tax bracket higher than the MFJ income tax bracket of the NOL year.

Example 2.12 Separate Returns

Tom and Mary Katt have no children, have no investment income, do not itemize deductions, and are both under age 65. Figure 2.8 shows their AGI for 2015 and 2013 (the first carryback year).

FIGURE 2.8 Tom and Mary’s AGI

2015 AGI 2013 AGI

Tom ($19,000) $30,000

Mary 21,500 40,000

Total $ 2,500 $70,000

If Tom files a MFS 2015 return, his NOL is $19,000.

If Tom and Mary file a MFJ return for 2015, their income tax is zero, but they have no NOL

can be used to offset only the taxpayer’s share of the taxable income on the MFJ return with the first spouse [Rev. Rul. 60-216, 1960-1 C.B. 126].

Summary of Allocation Rules

The rules for allocating NOLs and income and deductions are summarized in Figure 2.7.

FIGURE 2.7 Allocation Requirements for Spousal NOLs

NOL Year Carryback/Carryforward Year

Filing Status Single MFJ MFS

Single No allocationsIncome and deductions

allocatedNo allocations

MFJ NOL allocated No allocations NOL allocated

MFS No allocations No allocations No allocations


S Corporations and Partnerships 53

2Sale of Assets Used in a Trade or Business

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.

Example 2.14 Sale of an Asset Used in a Trade or Business

Calvin Hobbs realized a $5,000 loss when he sold a machine that he used in his shoe repair busi-ness. That loss is a business loss in calculating his NOL.

S Corporations and Partnerships

S corporations and partnerships cannot carry business losses to other tax years by deducting NOLs. Instead, the losses flow through to the shareholders or partners in the loss year and become a part of the shareholder’s or partner’s NOL calculation on their individual returns. These gains and losses are characterized as busi-ness or nonbusiness according to their status inside the S corporation or partnership.

Example 2.15 S Corporation Gain

Georgia Gentry operates her construction busi-ness as an S corporation and is the sole share-holder. The corporation realized a $7,000 gain on the sale of land used in the business. That gain flows through to Georgia and is treated as a busi-ness capital gain in calculating Georgia’s NOL.

Example 2.16 Partnership Loss

Theodore Bare is a 25% partner in a partnership that leases cars under long-term leases. The part-nership realized a $40,000 loss from its leasing activity in 2015. Theodore has no other passive income or losses in 2015. Theodore’s $10,000 share of the loss is a passive loss. Because he has

SPECIAL ISSUES IN NOL CALCULATIONS One of the most difficult issues in calculating an NOL is deciding whether a particular gain or loss is part of the NOL�

The treatments of passive activity losses, gains and losses from sales of business assets, and pass-through gains and losses from partnerships and S corporations are three common issues in the NOL calculation.

Passive Activity Losses

The passive activity loss rules are applied before the NOL rules. Therefore, only losses that are currently deductible under the passive loss rules can become a part of an NOL. A loss that is sus-pended 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.

Example 2.13 Passive Loss Inclusion in NOL

Bridgett Briley has a $30,000 loss from her rental real estate activity in 2015. Under the passive loss rules, she can deduct $25,000 of that loss in 2015, and the remaining $5,000 is carried to 2016.

The $25,000 deduction that is allowed under the passive loss rules is treated as a business loss in calculating Bridgett’s NOL for 2015 and is not included as a nonbusiness loss on line 9 of Sched-ule A (Form 1045). That means it will contribute to Bridgett’s NOL for 2015, if she has one.

If the $5,000 loss that is carried to 2016 is allowed as a deduction in 2016 under the passive loss rules (i.e., Bridgett has passive income, she is permitted to deduct it under the active participa-tion allowance for rental real estate losses, or she disposed of the entire passive activity that gener-ated the $5,000 loss carryover), it is treated as a business loss in calculating Bridgett’s 2016 NOL.


54 SPECIAL ISSUES IN NOL CALCULATIONS

2. Capital losses are allowed only to the extent of capital gains.

Because nonbusiness capital losses are included in both of the above rules, the rules interact in adding back losses and deductions that were used in calculating the negative income reported on line 1 of Schedule A (Form 1045) but that are not allowed in computing an NOL.

Completing lines 2 through 22 of the sched-ule requires sorting the taxpayer’s capital losses, capital gains, ordinary deductions, and ordinary income into business and nonbusiness portions. The first four worksheets in the appendix of this chapter help with that sorting process. They are completed for this case study.

The Wires’ $900 short-term capital loss from Schedule D (Form 1040) is reported on line A of NOL Worksheet 1 and is treated as a nonbusi-ness capital loss for purposes of the NOL compu-tation. Their $500 capital gain from Form 4797 is reported on line F of NOL Worksheet 2 and is treated as a business capital gain for purposes of the NOL computation. The Wires’ ordinary deductions and income are sorted out on NOL Worksheet 3 and NOL Worksheet 4 respectively.

On line P of NOL Worksheet 3, the state income tax is allocated pro rata between nonbusi-ness and business amounts based on the nonbusi-ness and business income in 2014, the year for which the taxes were paid. Therefore, $23 [$500 × ($2,000 ÷ $43,000)] is allocated to nonbusiness and $477 [$500 × ($41,000 ÷ $43,000)] is allo-cated to business. The $3,500 real estate tax is allocated to nonbusiness because it was paid for the Wires’ personal residence.

The preceding information is all that is neces-sary to complete lines 2 through 22 of Schedule A (Form 1045), as shown in Figure 2.10.

no passive income in 2015, it is suspended under the passive loss rules and therefore is not a part of his 2015 NOL calculation. It will become a part of his NOL calculation in the year it is allowed as a deduction under the passive loss rules.

MAKING OPTIMAL USE OF AN NOL DEDUCTION The tax benefit of an NOL can be squandered if other tax benefits are used in the loss year or in a year the NOL deduction is claimed�

Tax benefits may waste NOLs in two ways.

1. They may reduce an NOL in a loss year, even though they do not reduce taxable income in that or any other year.

2. In years that an NOL deduction is claimed (carryback and carryforward years), other tax benefits may reduce the NOL to be carried to subsequent years even though they do not reduce taxable income in that year or any other year.

Because some of those tax benefits could be shifted to another tax year, it is useful to know which ones waste NOLs.

NOL Planning: Case Study

Barb and Guy Wire are married, have two chil-dren, and file a MFJ return. Figure 2.9 reports their income and deductions for 2013, 2014, and 2015.

The Wires’ $22,500 NOL for 2015 is calcu-lated on Schedule A (Form 1045), as shown in Figure 2.10.

The first entry on Schedule A (Form 1045) is the $38,000 negative amount from line 41 of Form 1040. This is AGI reduced by the standard deduction or itemized deduction. The personal exemptions deduction is not subtracted because it is not allowed in computing an NOL [I.R.C. § 172(d)(3)].

Lines 2 through 22 of Schedule A (Form 1045) apply two of the NOL rules:

1. Nonbusiness deductions are allowed in com-puting an NOL only to the extent of nonbusi-ness income.


NOL Planning: Case Study 55

2

FIGURE 2.9 Income and Deductions for Barb and Guy Wire(Line references are to the 2015 forms.)

2013 (2nd Prior Year)

2014 (1st Prior Year)

2015 (Loss Year)

IncomeWages (line 7, Form 1040) $ 9,000 $ 10,000 $ 6,477Taxable interest (line 8a, Form 1040) 2,000 2,000 2,000Business income or loss (line 12, Form 1040) 21,000 31,000 (32,000)Capital gains and losses (line 13, Form 1040): Short-term [line 7 Schedule D (Form 1040)] 0 0 (900) Long-term [line 8a, Schedule D (Form 1040)] (1,000) 0 0 Gain from Form 4797 [line 11, Schedule D

(Form 1040)] 0 0 500Ordinary gain (loss) from Form 4797 (line 14, Form

1040) 0 0 3,000Jury duty pay (line 21, Form 1040) 0 0 100 Total Income (line 22, Form 1040) $31,000 $ 43,000 $(20,823)

Adjustments Deductible part of self-employment tax (line 27, Form

1040) $ 1,484 $ 2,190 $ 0Domestic production activities deduction (line 35,

Form 1040) 1,000 1,000 1,000Jury duty pay turned over to employer (line 36, Form

1040) 0 0 100Total adjustments (line 36, Form 1040) 2,484 3,190 1,100

Adjusted gross income (line 37, Form 1040) $28,516 $ 39,810 $(21,923)Itemized Deductions

Medical expenses [line 1, Schedule A (Form 1040)] $ 5,000 $ 5,000 $ 5,477Minus 10% of AGI (line 3, Schedule A (Form 1040)] ( 2,852) ( 3,981) 0Medical deduction [line 4, Schedule A (Form 1040)] 2,148 1,019 5,477State income taxes [line 5, Schedule A (Form 1040)] 500 500 500Real estate taxes [line 6, Schedule A (Form 1040)] 3,500 3,500 3,500Home mortgage interest [line 10, Schedule A (Form

1040)] 6,000 6,000 6,000Misc� itemized deductions (line 24, Schedule A (Form

1040)] 600 600 600Minus 2% of AGI [line 26, Schedule A (Form 1040)] ( 570) (796) 0Net misc� itemized deductions [line 27, Schedule A

(Form 1040)] 30

0

600

Total itemized deductions [line 29, Schedule A (Form 1040)] $ 12,178 $ 11,019 $ 16,077

Line 41, Form 1040 (AGI minus itemized deductions) $ 16,338 $28,791 $(38,000) Personal exemptions deduction (line 42, Form 1040) 15,600 15,800 16,000 Taxable Income (line 43, Form 1040) $ 738 $ 12,991 $ (54,000)

Income tax (line 44, Form 1040) $ 74 $ 1,298 $ 0Self-employment tax (line 57, Form 1040) 2,967 4,380 0 Total Tax Liability (line 63, Form 1040) $ 3,041 $ 5,678 $ 0


56 MAKING OPTIMAL USE OF AN NOL DEDUCTION

FIGURE 2.10 Wires’ NOL for 2015



2

on line 3. In this example the amount is zero because the business capital gains exceed the business capital losses.

■■ Line 15: Enter $900, the sum of

1. $900 from line 4: the nonbusiness capital losses that must be added back because they exceed nonbusiness capital gains; and

2. $0 from line 14: the business capital losses that must be added back because they exceed the sum ofa. the business capital gains, plusb. the excess nonbusiness capital gains.

■■ Line 16: Enter the $400 net capital loss from line 16 of Schedule D (Form 1040) ($500 long-term gain and $900 short-term loss).

■■ Line 17: Enter zero because there is no I.R.C. § 1202 exclusion in this example.

■■ Line 18: Subtract zero from the $400 entered on line 16 and enter $400.

■■ Line 19: Enter as a positive number the $400 loss from line 21 of Schedule D (Form 1040).

■■ Line 20: Enter zero because line 18 is not more than line 19.

■■ Line 21: Enter zero because line 19 is not more than line 18.

■■ Line 22: Subtract zero from $900 and enter $900.

■■ Line 23: Enter the $1,000 domestic produc-tion activity deduction.

■■ Line 24: There is nothing to enter in this example because the Wires had no previous NOLs.

■■ Line 25: Combine the negative $38,000 on line 1 with the positive $13,600 on line 9, the positive $900 on line 22, and the posi-tive $1,000 on line 23. Enter the negative $22,500 result as a negative number.

Planning to Avoid Wasting DeductionsThe Wires came to your office in November 2015 and asked for tax-planning advice. Figure 2.11 reports a projection of their 2016 income and deductions.

Schedule A—NOL in Figure 2.10 is completed as follows:

■■ Line 2: Enter the $900 nonbusiness capital loss from NOL Worksheet 1.

■■ Line 3: Enter zero because the Wires have no nonbusiness capital gains from NOL Worksheet 2.

■■ Line 4: Enter the $900 excess of line 2 over line 3. The purpose of line 4 is to prevent a taxpayer from using nonbusiness capital losses in excess of nonbusiness capital gains as part of an NOL that will be carried to another tax year. In this example the $900 is included on line 15, reduced by the zero on line 20, and entered on line 22.

■■ Line 5: Enter zero because line 3 does not exceed line 2. If line 3 did exceed line 2, the excess could be used to qualify nonbusi-ness ordinary deductions for purposes of the NOL computation. See line 8 of Schedule A (Form 1045).

■■ Line 6: Enter $15,600, the nonbusiness item-ized deductions from NOL Worksheet 3 (in the appendix of this chapter).

■■ Line 7: Enter the $2,000 of interest, which is treated as nonbusiness income.

■■ Line 8: Enter $2,000, the sum of lines 5 and 7.

■■ Line 9: Enter $13,600, the excess of line 6 over line 8. The purpose of line 9 is to add back ordinary nonbusiness deductions that exceed nonbusiness income. That amount is not allowed as part of the NOL because the NOL rules allow only business losses to be carried to another tax year.

■■ Line 10: Enter zero because line 8 is less than line 6.

■■ Line 11: Enter zero because there are no business capital losses from NOL Worksheet 1.

■■ Line 12: Enter $500, the business capital gains from NOL Worksheet 2.

■■ Line 13: Enter $500, the sum of lines 10 and 12.

■■ Line 14: Enter zero because line 11 is not more than line 13. Line 14 is designed to calculate the business capital losses that must be added back to the taxable income (loss)



possible. Above-the-line nonbusiness deductions such as alimony payments should also be shifted whenever possible. If the taxpayers are making less than the maximum retirement plan contribu-tions, they could bunch contributions in the years where they would offset taxable income or add to the NOL.

If Barb and Guy do nothing to change the income and deductions estimated in Figure 2.11, they will not benefit from $13,600 of their nonbusi-ness deductions in 2015 [the difference between lines 6 and 7 on Schedule A (Form 1045)]. If they wait until 2016 to pay the $3,500 of real estate taxes that they planned to pay in 2015, they will preserve the benefit of that deduction. The Sched-ule A (Form 1045) in Figure 2.12 shows that their 2015 NOL remains the same ($22,500) even though the $3,500 real estate taxes are moved to 2016. That is because real estate taxes are part of the excess nonbusiness deductions that must be added back to calculate an NOL. The extra $3,500 of real estate taxes in 2016 will reduce the 2016 taxable income by $3,500. Therefore, shift-ing the real estate taxes from 2015 to 2016 pre-serves the value of the deduction.

2015 NOL Remains the Same

Even though the $3,500 real estate tax deduc-tion is shifted to 2016, the 2015 NOL remains the same� Lines 1 and 9 each change by $3,500, but they change in opposite directions and cancel each other out�

Barb and Guy could further reduce their 2016 taxable income without decreasing their 2015 NOL by shifting up to $10,100 of other nonbusi-ness deductions to 2016.

Shifting Nonbusiness Income to Loss YearThe problem of nonbusiness deductions in excess of nonbusiness ordinary income plus excess non-business capital gains can also be alleviated by increasing the total amount of nonbusiness ordi-nary income and nonbusiness capital gains in the loss year. Such an increase will be effectively tax-free until the sum of nonbusiness ordinary income and excess nonbusiness capital gains equals nonbusiness deductions.

FIGURE 2.11 Projection of 2016 Income and Deductions

Income

Wages $10,000

Interest 9,000

Business income or (loss) 30,000

Business capital gain 6,000

Nonbusiness capital gain 2,000

Business capital loss 0

Total $57,000

Adjustments to income

Domestic production activity deduction ( $ 1,000)

Adjusted gross income $56,000

Itemized deductions

Taxes: State income (withholding) $ 3,000

Real estate 4,000

Mortgage interest expense 6,000

Total $ 13,000

Personal exemptions deduction* $16,000

Taxable income (loss) $27,000

* The $4,000 deduction for personal and dependent exemptions for 2015 is used to estimate the 2016 deduction for personal and dependent exemptions.

Excess Nonbusiness DeductionsIf nonbusiness deductions exceed nonbusiness ordinary income plus excess nonbusiness capital gains in an NOL year, the excess nonbusiness deductions will never provide a tax benefit. Therefore, those deductions should be shifted to another tax year if possible.

■■ If those deductions are shifted to a year that has no NOL, they will offset taxable income in that year.

■■ If they are shifted to a year when there is an NOL but nonbusiness ordinary income plus net nonbusiness capital gains exceed non-business deductions, they will increase the NOL.

Shifting excess nonbusiness deductions involves the same kind of planning as bunching itemized deductions every other year and claim-ing the standard deduction in the alternate years. Therefore, medical expenses, taxes, interest expenses, charitable contributions, and miscel-laneous deductions should be shifted as much as



2

FIGURE 2.12 2015 NOL after Shifting $3,500 of Real Estate Taxes to 2016



NOL Unchanged

Even though the $900 business capital loss is shifted from 2015 to 2016, the 2015 NOL remains the same� Lines 1 and 22 each change by $900, but they change in opposite directions and wash each other out�

Waiving Carryback May Reduce Tax Liability

In some cases an NOL deduction is more useful to the taxpayer in the years following the NOL year than in the carryback years because of the higher tax rates imposed in high-income years. If the carryback years have low income compared to carryforward years, forgoing the carryback is advantageous as long as the 20 carryforward years will use most or all of the NOL.

Capital losses in carryback or carryforward years may keep the taxpayer from realizing the full benefit of the NOL deduction in those years. Similarly, the NOL deduction may cause the loss of a tax credit that cannot be carried beyond the carryback or carryforward year. (For example, an investment tax credit is wasted if an NOL is car-ried to the final year the credit can be claimed and the NOL reduces taxable income to zero for that year.) In these cases the election can be used to minimize the loss of the NOL deduction or credit.

Finally, there may not be enough taxable income in the carryforward years to absorb the NOL. In those cases the NOL should be carried back to the low-income years to reduce low-bracket income rather than be completely wasted.

Present Value of Carryforward

Because the timing of the tax savings differs between carrying an NOL back and carrying it forward, the present value of the tax savings must be computed to properly compare them. If the NOL is carried back, the tax savings will be received shortly after the refund claim is filed. The following discussion assumes that the request for refund is filed early in the year following the

If nonbusiness ordinary income is shifted from a year without an NOL to an NOL year in which nonbusiness deductions exceed the total of nonbusiness ordinary income and net nonbusi-ness capital gains, the shifted income is tax-free. The same result occurs if nonbusiness ordi-nary income is shifted from an NOL year with an excess of nonbusiness ordinary income and net nonbusiness capital gains over nonbusiness deductions.

If Barb and Guy could shift $900 of inter-est income from 2016 to 2015, their 2016 tax-able income would be reduced by $900 without reducing their 2015 NOL. The Schedule A (Form 1045) in Figure 2.13 shows that the extra $900 of interest income reduces their loss on line 1 but also reduces the amount of nonbusiness deduc-tions that must be added back on line 9 by increas-ing the nonbusiness income on line 7. Therefore, their 2015 NOL is unchanged.

2015 NOL Is Unchanged

Even though $900 of interest income is shifted from 2016 to 2015, the 2015 NOL shown above remains the same� Lines 1 and 7 each increase by $900 and therefore wash each other out�

Excess Nonbusiness Capital LossesNonbusiness capital losses in excess of nonbusi-ness capital gains provide no tax benefit in an NOL year because they are not allowed as part of the NOL computation. If those capital losses are shifted to a year when there is no NOL, or to an NOL year that has excess nonbusiness capital gains, the losses will provide a tax benefit. If Barb and Guy shift their $900 nonbusiness capital loss from 2015 to 2016, they will not reduce their 2015 NOL (as shown in Figure 2.14), and they will reduce their 2016 taxable income by $900.


2

Present Value for Carryforward 61

FIGURE 2.13 2015 NOL after Shifting $900 of Interest Income to 2015



FIGURE 2.14 2015 NOL after Shifting $900 of Capital Loss to 2015


Present Value of Carryforward 63

2

■■ Figure 2.15 should be used if the tax savings are used to reduce estimated tax payments.

■■ Figure 2.16 should be used if the tax sav-ings are used to reduce the tax paid with the return or increase the refund claimed on the return.

The tax savings that result from carrying the NOL forward must be estimated for each year fol-lowing the NOL year. Those tax savings are then multiplied by the appropriate factor from the applicable table. The interest rate is the oppor-tunity cost of the taxpayer’s capital—that is, the after-tax rate the taxpayer is paying or would pay to borrow money. (If the taxpayer is not borrow-ing money, the appropriate rate is the after-tax rate the taxpayer is earning on investments.)

NOL year and the refund is received by April 15 of that year.

If the NOL is carried forward, the tax sav-ings are realized when taxes would otherwise be paid in the carryforward years. The NOL deduc-tion can be used to reduce quarterly estimated tax payments, or it can be used to reduce the tax paid or increase the refund received when the carryforward-year return is filed. In either case the present value is less than the face amount of the tax savings.

To compare the value of future tax savings with the value of refunds from previous years, the present value of future tax savings as of April 15 can be calculated. The tables in Figures 2.15 and 2.16 give discount factors for taxes saved in the 5 years following the NOL year.

FIGURE 2.15 Factors for Calculating Present Value of Taxes Saved in Years Following NOL Year, Assuming Savings Are Used to Reduce Quarterly Estimated Tax Payments

Interest Rate Year 1* Year 2** Year 3** Year 4** Year 5**

1% 0�9967 0�9868 0�9770 0�9674 0�9578

2% 0�9934 0�9739 0�9548 0�9361 0�9177

3% 0�9901 0�9613 0�9333 0�9061 0�8797

4% 0�9868 0�9489 0�9124 0�8773 0�8436

5% 0�9836 0�9368 0�8922 0�8497 0�8092

6% 0�9804 0�9249 0�8725 0�8232 0�7766

7% 0�9772 0�9133 0�8535 0�7977 0�7455

8% 0�9740 0�9019 0�8351 0�7732 0�7159

*These factors were calculated using the following formula: Factor = [1 + {1 + (i ÷ 12)}-2 + {1 + (i ÷12)}-5 + {1+ (i ÷ 12)}-9] ÷ 4, where i = interest rate divided by 100.

**These factors were calculated using the following formula: Factor = F × (1 + i)-(n-1), where F = the Year 1 factor, i = interest rate divided by 100, and n = year.

FIGURE 2.16 Factors for Calculating Present Value of Taxes Saved in Years Following NOL Year, Assuming Savings Are Used to Reduce Payment or Increase Refund with Tax Return

Interest Rate Year 1* Year 2* Year 3* Year 4* Year 5*

1% 0�9901 0�9803 0�9706 0�9610 0�9515

2% 0�9804 0�9612 0�9423 0�9238 0�9057

3% 0�9709 0�9426 0�9151 0�8885 0�8626

4% 0�9615 0�9246 0�8890 0�8548 0�8219

5% 0�9524 0�9070 0�8638 0�8227 0�7835

6% 0�9434 0�8900 0�8396 0�7921 0�7473

7% 0�9346 0�8734 0�8163 0�7629 0�7130

8% 0�9259 0�8573 0�7938 0�7350 0�6806

* These factors were calculated using the following formula: Factor = (1 + i)-n, where i = interest rate divided by 100 and n = year.



must be discounted by a factor from Figure 2.15. If their after-tax opportunity cost of capital is 4%, the appropriate factor is 0.9868, and the present value of the $6,686 tax savings is $6,598. Con-sequently, Scott and Erin should forgo the NOL carryback because the $6,598 ($6,686 × 0.9868) present value of the future tax savings from the carryforward option is greater than the $6,506 refund received by using the carryback option.

To forgo the NOL carryback, Scott and Erin must attach the statement shown in Figure 2.18 to their timely filed (including extensions) 2015 income tax return.

FIGURE 2.18 Election to Forgo NOL Carryback

Scott and Erin Jackson SSN 172-09-1045

Taxpayers elect to forgo the net operating loss carryback period under I.R.C. § 172(b)(3)(C) for the net operating loss shown on this return.

If the 2016 tax savings will not be realized until their tax return is filed in 2017, the tax savings must be discounted by a factor from Figure 2.16. If their after-tax opportunity cost of capital is 4%, the appropriate factor is 0.9615, and the present value of the $6,686 tax savings is $6,429 ($6,686 × 0.9615). Consequently, Scott and Erin should carry the NOL back and claim a refund for taxes paid because the $6,508 refund is greater than the $6,429 present value of the future tax savings.

Wasted NOL Deduction

Carrying the NOL to a year in which the taxable income it reduces is less than the amount of the NOL that is absorbed wastes part of the NOL� That waste is a bigger factor in making optimal use of the NOL than the discounting of tax savings real-ized by carrying the NOL forward�

In Example 2�17, the $55,000 NOL was fully absorbed by the $57,103 ($49,303 taxable income plus $7,800 personal exemptions deduction) of modified taxable income in the 2013 carryback year even though it offset only $49,303 of tax-able income� If the 2013 taxable income had been $55,000, the tax without the NOL carryback would

Example 2.17 Present Value Calculations

Scott and Erin Jackson had a $55,000 NOL in 2015. Their income and deductions from 2013 and their expected income and deductions for 2016 are shown in Figure 2.17.

FIGURE 2.17 Jacksons’ 2013 and 2016 Income and Deductions

2013 (First Carryback

Year)

2016 (First Carryforward

Year)*

Income

Wages (line 7, Form 1040) 24,195 0

Taxable interest (line 8a, Form 1040) $ 7,000 $ 7,000

Business income (line 12, Form 1040) 41,005 69,200

Total income (line 22, Form 1040) $72,200 $ 76,200

Adjustments

Deductible part of SE Tax (line 27, Form 1040) 2,897 4,889

Adjusted gross income (line 37, Form 1040) $69,303 $71,311

Standard deduction (line 40, Form 1040) 12,200 12,600

Personal exemptions deduction (line 42, Form 1040) 7,800 8,000

Taxable income (line 43, Form 1040) $49,303 $ 50,711

Income tax (line 44, Form 1040) $ 6,506 $ 6,686

* The 2015 deductions and tax rates were used to estimate the 2016 deductions and tax rates.

If Scott and Erin carry their $55,000 NOL from 2015 back to 2013, they will reduce their 2013 income taxes to zero, and they can claim a $6,506 refund. The NOL would be fully absorbed in 2013, so there would be no carryforward to 2014.

If Scott and Erin forgo the carryback, the $55,000 NOL from 2015 will reduce their 2016 income taxes from $6,686 to zero. The NOL would be fully absorbed in 2016, so there would be no carryforward to 2017.

If the tax savings will be realized by reducing the estimated payments for 2016, the tax savings


2

Appendix 65

Control Timing of NOL

If the taxpayer has some discretion in determin-ing the tax year when an NOL is realized, it should be placed in the year where it will gener-ate the greatest tax benefit. The years in which the NOL generates the greatest benefit are those that have the highest taxable income (and are there-fore in the highest marginal bracket) and those with little long-term capital gain or tax credits that will waste the NOL. For example, if a tax-payer’s marginal tax rate is higher in 2013 than in 2014, accelerating an NOL into 2015 instead of delaying it to 2016 will cause the NOL to be car-ried back to 2013 where it will offset the higher-bracket 2013 income instead being carried back to 2014 to offset the lower-bracket 2014 income.

Use Up NOL Before It Expires

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.

have been $7,361� Carrying the $55,000 NOL back to 2013 would have still reduced the 2013 taxes to zero, saving $7,361 of taxes, compared to only $6,686 (before discounting) saved by waiving the carryback and carrying the $55,000 NOL forward to 2016�

Also in Example 2�17, if Scott and Erin elected to forgo carryback, the $55,000 NOL would be fully absorbed by the $58,711 ($50,711 taxable income plus $8,000 personal exemptions deduc-tion) of modified taxable income in 2016 even though it offset only $50,711 of taxable income� If the 2016 taxable income had been $55,000, the tax without the NOL carryforward would have been $7,331� Carrying the $55,000 NOL forward to 2016 would have still reduced the 2016 taxes to zero, saving $7,331 of taxes, compared to only $6,508 saved by carrying the $55,000 NOL back to 2013� The discounted value of the 2016 tax reduc-tion would have been $7,234 ($7,331 × 0�9868) of estimated taxes or $7,049 ($7,331 × 0�9615) of tax paid with the 2016 tax return�

APPENDIX

The first four worksheets in this appendix guide tax practitioners when calculating (1) business and nonbusiness capital gains and losses and (2) nonbusiness deductions and income, which are required to complete Schedule A (Form 1045). These worksheets are filled in for the case study presented earlier in this chapter. The fifth work-sheet computes itemized deductions for an inter-vening year. It is not illustrated in this chapter.


66 APPENDIX

NOL Worksheet 1 for NOL Planning Case Study Allocation of capital losses between nonbusiness capital losses and business capital losses

[Use this worksheet to complete lines 2 and 11 of the 2015 Schedule A (Form 1045)]

Where Loss Is Reported on Tax Return

Amount Reported on Tax Return Disposition Nonbusiness Business

2015 Sch. D (Form 1040)1

A� Lines 1a, 1b, 2, and 3 column h 900 Allocate2 900

B� Line 4, column h Allocate2

C� Line 5, column h Allocate3

D� Line 6, column h Allocate4

E� Lines 8a–10, column h Allocate2

F� Line 11, column h Allocate2

G� Line 12, column h Allocate3

H� Line 14, column h Allocate4

I� TOTALS 900 9005 5

1. Enter the amount from the designated lines on Schedule D (Form 1040) only if they are losses. Enter the amounts as positive numbers.

2. In most cases losses reported on lines 1–4, 8–10, and 13 of Schedule D (Form 1040) are nonbusiness capital losses for pur-poses of the NOL calculation. Losses from property used in a trade or business are reported on Form 4797, and if there is a net I.R.C. § 1231 loss for the year, the net loss is treated as an ordinary deduction. However, in rare cases losses reported on those lines can be business capital losses if the asset on which the loss was realized was an I.R.C. § 1221 asset rather than an I.R.C. § 1231 asset but was purchased for a trade or business reason rather than for investment. For example, loss realized on stock in another company that was purchased to enhance the taxpayer’s business is reported on one of those lines but is treated as a business capital loss for the NOL calculation. See Crow v. Commissioner, 79 T.C. 541 (1982).

3. The character of the loss reported on line 5 or 12 of Schedule D (Form 1040) is determined by the character of the loss to the partnership, S corporation, or fiduciary. In most cases losses reported on lines 5 and 12 of Schedule D (Form 1040) are non-business capital losses, but see footnote 2 for a discussion of the rare cases in which losses from an I.R.C. § 1221 asset may be treated as a business capital loss for the NOL calculation.

4. Capital loss carryovers must be allocated between business and nonbusiness capital losses according to the proportionate contribution of business and nonbusiness capital losses to the capital loss carryover.

5. Enter the total nonbusiness capital losses and total business capital losses on lines 2 and 11 of the 2015 Schedule A (Form 1045) respectively.


2

Appendix 67

NOL Worksheet 2 for NOL Planning Case Study Allocation of capital gains between nonbusiness capital gains and business capital gains

[Use this worksheet to complete lines 2 and 11 of the 2015 Schedule A (Form 1045)]

Where Gain Is Reported on Tax Return

Amount Reported on Tax Return Disposition Nonbusiness Business

2015 Sch. D (Form 1040)1

A� Lines 1 & 2, column h Allocate2

B� Line 4, column h Allocate2

C� Line 5, column h Allocate3

D� Line 8a, column h Allocate2

E� Lines 8b–10, column h Allocate2

F� Line 11, column h 500 Allocate4 500

G� Line 12, column h Allocate3

H� Line 13, column h Allocate2

I� TOTALS 500 5 500 5

1. Enter the amounts from the designated lines only if they are gains.2. In most cases gains reported on lines 1–4, 8–10, and 13 of Schedule D (Form 1040) are nonbusiness capital gains for purposes

of the NOL calculation because gains from property used in a trade business are reported on Form 4797 and are carried to line 11 of Schedule D (Form 1040) if they are treated as long-term capital gain. However, in rare cases gains reported on lines 1–4, 8–10, and 13 of Schedule D (Form 1040) can be business capital gains if the asset on which the gain was realized was an I.R.C. § 1221 asset rather than an I.R.C. § 1231 asset but was purchased for a trade or business reason rather than for invest-ment. For example, gain realized on stock in another company that is purchased to enhance the taxpayer’s business is reported on one of those lines but is treated as a business capital gain for the NOL calculation. See Crow v. Commissioner, 79 T.C. 541 (1982).

3. The character of the gain reported on line 5 or 12 of Schedule D (Form 1040) is determined by the character of the gain to the partnership, S corporation, or fiduciary. In most cases gains reported on lines 5 and 12 of Schedule D (Form 1040) are non-business capital gains, but see footnote 2 for a discussion of the rare cases in which gains from an I.R.C. § 1221 asset may be treated as a business capital gain for the NOL calculation.

4. Gain from Form 4797, Part I, is business gain. Gain from Form 2439, Form 4684, Form 6252, Form 6781, or Form 8824 is nonbusiness gain in most cases. See footnote 2 for a discussion of the rare cases in which gains from an I.R.C. § 1221 asset may be treated as a business capital gain for the NOL calculation.

5. Enter the total nonbusiness capital gains and total business capital gains on lines 3 and 12 respectively of the 2015 Schedule A (Form 1045).


68 APPENDIX

NOL Worksheet 3 for NOL Planning Case Study Allocation of deductions between business deductions and nonbusiness deductions

[Use this worksheet to complete line 6 of the 2015 Schedule A (Form 1045)]

Location on 2015 Form 1040 Item

Amount on Tax Return Disposition Business Nonbusiness

AMT- Nonbusiness

A� Line 23 Educator expenses Business

B� Line 24 Reservists, artists, etc� Business

C� Line 25 HSA deduct� Nonbusiness

D� Line 26 Moving expenses Business

E� Line 27 Deductible part of SE tax

Business

F� Line 28 Keogh, SEP, SIMPLE, etc�

Nonbusiness

G� Line 29 SE health insurance Nonbusiness

H� Line 30 Penalty, early withdrawal

Nonbusiness

I� Line 31a Alimony paid Nonbusiness

J� Line 32 IRA deduction Nonbusiness

K� Line 33 Student loan interest deduction

Nonbusiness

L� Line 34 Tuition & fees deduction

Nonbusiness

M� Line 36 Write-in expenses 100 Allocate1 100

N� Line 40 Std� ded� (if claimed) Nonbusiness 2

Schedule A (Form 1040) (if claimed)

O� Line 4 Medical 5,477 Nonbusiness 5,477 3

P� Line 9 Taxes 4,000 Allocate4 477 3,523

Q� Line 15 Interest 6,000 Nonbusiness 6,000 5

R� Line 19 Contributions Nonbusiness

S� Line 20 Casualty and theft

Business

T� Line 27 Misc� (2% floor) 600 Allocate6 600

U� Line 28 Other misc� deductions

Allocate7

V� TOTALS 16,177 577 15,6008

1. Most write-in adjustments on line 36 of Form 1040 are business deductions. However, Treas. Reg. § 1.172-3(a)(3)(i) defines nonbusiness deductions for purposes of computing an NOL as those that are not derived from or attributable to a taxpayer’s trade or business, and it includes wages and salary in income attributable to the taxpayer’s trade or business. Therefore, the following write-in adjustment items are likely to be treated as business deductions for computing a noncorporate NOL:

a. Jury duty pay an employee turned over to the employer because the employer paid the employee’s salary while the employee served on the jury

b. Reforestation amortization and expenses2. If the standard deduction is claimed for the regular tax, neither the standard deduction nor the itemized deductions can be claimed for the

AMT.3. The medical deduction floor is 10% of AGI for AMT purposes.4. State and local income taxes paid are allocated between business and nonbusiness deductions according to the income of the year that

created the taxes. For this allocation salaries and wages are treated as business income. Taxes are not allowed as a deduction when calculat-ing AMT.


2

Appendix 69

NOL WORKSHEET 4 for NOL Planning Case Study Allocation of ordinary income between business and nonbusiness ordinary income

[Use this worksheet to complete line 7 of the 2015 Schedule A (Form 1045)]

Location on 2015 Form 1040 Item

Amount on Tax Return Disposition

Amount as Business

Amount as Nonbusiness

AMT Nonbusiness

A� Line 7 Wages, salary, etc� 6,477 Business 6,477

B� Line 8a Taxable interest 2,000 Nonbusiness 2,000 2,000

C� Line 8b Tax-exempt interest

Nonbusiness1

D� Line 9a Ordinarydividends

Nonbusiness

E� Line 10 Taxable refunds Allocate2

F� Line 11 Alimony received Nonbusiness

G� Line 12 Business income (loss) Sch� C

(32,000) Business (32,000)

H� Line 14 Form 4797 gains or losses

3,000 Business

3,000

I� Line 15b Taxable amount of IRA distributions

Nonbusiness

J� Line 16b Taxable amount of pensions

Nonbusiness

K� Line 17 Rents, royalties, and partnership income

Usually

business

L� Line 18 Farm income (or loss)

Business

M� Line 19 Taxable unemployment

Business

N� Line 20b Taxable social security benefits

Nonbusiness

O� Line 21 Other income 100 Allocate 100

P� TOTALS (20,423) (22,423) 2,0003 2,000

1. Nontaxable interest is nonbusiness income for AMT purposes only.2. The state and local income tax refund is allocated between business and nonbusiness income according to the income of the year that

created the refund. For this allocation salaries and wages are treated as business income. State and local income tax refunds are not included when calculating the AMT.

3. Enter the nonbusiness ordinary income on line 7 of the 2015 Schedule A (Form 1045).

5. The alternative minimum tax interest deduction is the same as the regular tax interest deduction except for the following adjustments:a. If debt on a personal residence has been refinanced, interest on debt in excess of the debt before refinancing cannot be deducted for

AMT purposes.b. The investment interest deduction must be recalculated to include income from private activity bonds in investment income and the

expenses on those bonds in investment expenses.6. Because the amount on line 27, Schedule A (Form 1040), is reduced by 2% of AGI, the amounts allocated to business and nonbusiness

deductions must be reduced on a pro rata basis. Therefore, the amount in the business column should be the amount from line 27, Sched-ule A (Form 1040), multiplied by the total business miscellaneous deductions subject to the 2% floor and divided by the total miscellaneous deductions subject to the 2% floor. The amount in the nonbusiness column should be the amount from line 27, Schedule A (Form 1040), multiplied by the total nonbusiness deductions subject to the 2% floor and divided by the total miscellaneous deductions subject to the 2% floor. These miscellaneous deductions are not allowed as a deduction when calculating AMT.

7. Deductions allowable for impairment-related work expenses are business deductions. Other deductions reported on line 28, Schedule A (Form 1040), are nonbusiness deductions.

8. Enter the total nonbusiness deductions on line 6 of the 2015 Schedule A (Form 1045).


70 APPENDIX

NOL Worksheet 5(Use this worksheet to compute the itemized deduction to enter

on line 12 of the “After carryback” columns of Form 1045 for a 2014 tax year)

Notes for entries on Schedule A (Form 1040):Line 2: Enter the AGI reported on line 11 of the “After carryback” column for the carryback year on Form 1045.Line 19: Figure the contribution deduction limit (50%, 30%, or 20% of modified AGI) using the AGI reported on line 11 of the “After carry-

back” column for the carryback year on Form 1045.Line 20: Calculate the casualty and theft loss deduction using the AGI reported on line 11 of the “After carryback” column for the carryback

year on Form 1045 to determine the 10%-of-AGI floor.Line 25: Enter the AGI reported on line 11 of the “After carryback” column for the carryback year on Form 1045.Line 29: Replace “Form 1040, line 38” with “the AGI reported on line 11 of the “After carryback” column for the carryback year on Form

1045 in the line instructions. Enter the amount from line 29 on line 12 of the “After carryback” column of Form 1045.


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