Net Operating Losses. Presented by: Keith Altobelli, EA

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1 Presented by: Keith Altobelli, EA

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3 Net Operating Losses Objectives In this webinar the student will learn to: Calculate an NOL Determine whether to carry an NOL back or forward To claim an NOL deduction Figure an NOL carryover.

4 Learn how to complete the following forms and worksheets Form 1045, Application for a Tentative Refund Form 1045, Schedule A - NOL Form 1045, Schedule B - NOL Carryover Worksheet for NOL Carryover From

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6 Definitions: Net Operating Losses NOL Year The tax year in which a net operating loss occurs. NOL Carryback The net operating loss that is initially carried back to year(s) preceding the loss year. These years are known as the carryback period. NOL Carryforward The net operating loss that is carried to the year(s) after the loss. These years are known as the carryforward period. NOL Carryover A carryover occurs when a net operating loss exceeds the taxable income of the year to which it was carried. Carryback Year Any tax year preceding the net operating loss year, to which a net operating loss is carried. Carryover Year Any succeeding year to which the remainder of a prior net operating loss is carried.

7 It is vital for practitioners to be aware of the opportunities and pitfalls created by an NOL. Practitioners must be able to explain NOL-related choices to their clients so that taxpayers can accurately decide what is best for them. Too many taxpayers lose the benefits of the special provisions of the Code relating to NOLs because their practitioners fail to present all options or simply fail to apply an NOL to other tax years.

8 When deductions exceed income, a net operating loss may occur.

9 Deductions from a trade or business, From working as an employee, From casualty and theft losses, moving expenses, or rental property. The most common NOL is caused by a business loss.

10 An NOL can be used by deducting the NOL from the taxpayer s income in another year (or years). This may result in a refund of prior years taxes.

11 Positive Or Negative?

12 The following items are not allowed when figuring an NOL: Deduction for personal exemptions Capital losses in excess of gains The section 1202 exclusion of 50% of the gain from the sale or exchange of qualified small business stock Nonbusiness deductions in excess of nonbusiness income. Net operating loss deduction from a prior year The domestic production activities deduction

13 The following items are not allowed when figuring an NOL: Deduction for personal exemptions Capital losses in excess of gains The section 1202 exclusion of 50% of the gain from the sale or exchange of qualified small business stock Nonbusiness deductions in excess of nonbusiness income. Net operating loss deduction from a prior year The domestic production activities deduction

14 2014 Net Operating Losses

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16 Glenn Johnson is in the retail record business. He is single and has the following income and deductions on his Form 1040 for INCOME Wages from part-time job $1,225 Interest on savings 425 Net long-term capital gain on sale of real estate used in business 2,000 Glenn's total income $3,650 DEDUCTIONS Net loss from business (gross income of $67,000 minus expenses of $72,000) $5,000 Net short-term capital loss on sale of stock 1,000 Standard deduction 5,950 Personal exemption 3,800 Glenn's total deductions $15,750

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18 The following items are not allowed when figuring an NOL: Deduction for personal exemptions Capital losses in excess of gains The section 1202 exclusion of 50% of the gain from the sale or exchange of qualified small business stock Nonbusiness deductions in excess of nonbusiness income. Net operating loss deduction from a prior year The domestic production activities deduction Therefore, Glenn's NOL for 2014 is figured as follows: Glenn's total 2014 income $3,650 Less: Glenn's original 2014 total deductions $15,750 Reduced by the disallowed items 10,325 5,425 Glenn's NOL for 2014 $1,775

19 Back: 2 Years Or not Forward: 20 Years

20 Waiving the Carryback Period An election can be made to waive the carryback years and only use the NOL in the 20-year carryforward period. (This choice also means that no alternative NOL is carried back.) The election must be made on a timely filed return (including extensions) for the NOL year. To make this election, the following statement must be attached to the return: The taxpayer elects to waive the net operating loss carryback period under section 172(b)(3) of the Internal Revenue Code. Once this election is made, it generally is irrevocable. If the taxpayer chooses to waive the carryback period for more than one NOL, a separate choice must be made and a separate statement attached for each NOL year.

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22 Eligible loss. The carryback period for eligible losses is 3 years. Only the eligible loss portion of the NOL can be carried back 3 years. An eligible loss is any part of an NOL that: Is from a fire, storm, shipwreck, casualty or theft, or Is attributable to a federally declared disaster for a qualified small business or certain qualified farming businesses.

23 Qualified small business: A qualified small business is a sole proprietorship or a partnership Average annual gross receipts (reduced by returns and allowances) of $5 million or less during the 3-year period ending with the tax year of the NOL. If the business did not exist for this entire 3-year period, use the period the business was in existence.

24 Farming loss: Only the farming loss portion A farming loss is the smaller of: The amount which would be the NOL for the tax year if only income and deductions attributable to farming businesses were taken into account, or The NOL for the tax year.

25 Farming business: Cultivation of land, raising or harvesting of any agricultural or horticultural commodity, operating a nursery or sod farm, raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees. The raising, shearing, feeding, caring for, training and management of animals is also considered a farming business. A farming business does not include contract harvesting of an agricultural or horticultural commodity grown or raised by someone else. It also does not include a business in which you merely buy or sell plants or animals grown or raised entirely by someone else.

26 Qualified disaster loss: Only the qualified disaster loss portion A qualified disaster loss is the smaller of the sum of: Any losses attributable to a federally declared disaster and occurring before January 1, 2010 in the disaster area, plus any allowable qualified disaster expenses (even if you did not choose to treat those expenses as deductions in the current year), or The NOL for the tax year.

27 Private or commercial golf course, Country club, Massage parlor, Hot tub facility, Suntan facility, Any store for which the principal business is the sale of alcoholic beverages for consumption off premises. Gambling or animal racing property. Gambling or animal racing property is any property used directly in connection with gambling, the racing of animals, or the on-site viewing of such racing, unless this portion is less than 100 square feet.

28 Qualified GO Zone loss: Only the qualified GO Zone loss portion A qualified GO Zone loss is the smaller of: The excess of the NOL for the year over the specified liability loss for the year to which a 10-year carryback applies, or The total of any qualified GO Zone casualty loss and any depreciation allowable for any specified GO Zone extension property for the year such property is placed in service (even if you elected not to claim the special GO Zone depreciation allowance for such property). In most cases, specified GO Zone extension property must have been placed in service before December 31, 2011.

29 Waiving the 5-year carryback: A taxpayer can choose to figure the carryback period for a farming loss without regard to the special 5-year carryback rule. To make this choice for 2014, attach to the 2014 tax return filed by the due date (including extensions) a statement that he or she is choosing to treat any 2014 farming losses without regard to the special 5-year carryback rule. If the return is filed on time but the statement was not filed with it, the choice can be made on an amended return filed within 6 months after the due date of the return (excluding extensions). Attach an election statement to the amended return, and write Filed pursuant to section at the top of the statement. Once made, this choice is irrevocable.

30 Specified liability loss: Only the specified liability loss portion A specified liability loss is a loss arising from: Product liability and expenses incurred in the investigation or settlement of, or opposition to, product liability claims, or An act (or failure to act) that occurred at least 3 years before the beginning of the loss year and resulted in a liability under a federal or state law requiring: Reclamation of land, Dismantling of a drilling platform, Remediation of environmental contamination, or Payment under any workers compensation act.

31 Waiving the 10-year carryback: A taxpayer can choose to figure the carryback period for a specified liability loss without regard to the special 10-year carryback rule. To make this choice for 2013, attach to the 2013 tax return filed by the due date (including extensions) a statement that he or she is choosing to treat any 2013 specified liability loss without regard to the special 10-year carryback rule. If the return is filed on time but the statement was not filed with it, the choice can be made on an amended return filed within 6 months after the due date of the return (excluding extensions). Attach a statement to the amended return, and write Filed pursuant to section at the top of the statement. Once made, this choice is irrevocable

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33 Farmer John had a $50K loss: $25K from farming $10K from fire in home How Many Years Can He Carry Back the Losses? $15K from wife employee loss

34 Use it or lose it

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36 Pertinent Info: Aspiring entertainer Head of Household Self-Employed Lucy Richards Had a bad year

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38 Non-Business Non-Business Now-Business Schedule D Section 1202 Small Business Stock Final NOL

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40 Pros: IRS has 90 days One claim for up to 3 years Better overall picture Cons: Must be filed within 1 year Payment no guarantee No TC if disallowed; 1040X IRS may bill for errors

41 Pros: Same deadline as original 6 months to process or court 2 years to appeal disallowance Cons: Separate form for each year Taxes more than 90 days Must adjust for deductions based on AGI

42 Applying the NOL to Past Returns The following items are adjusted in the order listed: 1. The special allowance for passive activity losses from rental real estate activities 2. Taxable social security and tier 1 railroad retirement benefits 3. IRA deductions 4. Excludable savings bond interest 5. Excludable employer-provided adoption benefits 6. The student loan interest deduction 7. The tuition and fees deduction

43 After all items are refigured: the following deductions are recalculated based on AGI: 1. Medical expenses 2. Qualified mortgage insurance premiums 3. Casualty losses 4. Miscellaneous itemized deductions 5. Overall limit on itemized deductions 6. Phaseout of exemptions The deduction for charitable contributions is not recalculated.

44 The final step in the applying the NOL to past returns is that taxes and credits are recalculated. SE tax is not affected by NOL carrybacks and carryforwards.

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46 1 st year only!

47 NOL Adjustment

48 2014 NOL $80, NOL Used $55, Carryover $25,775

49 All Subsequent Years

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54 1. Answer any question before they know they have one! 2. Form st 2 pages 3. IRA Contributions Schedule A 5. Any other forms that have changed

55 Recreate each year separately Carryover Line 13 if negative after Tax refund on Line 27

56 Disallowance of the Application: Your application is not treated as a claim for credit or refund. It may be disallowed if it has material omissions or math errors that are not corrected within the 90-day period. If the application is disallowed in whole or in part, no suit challenging the disallowance can be brought in any court. But you can file Form 1040X

57 Deducting a Carry-forward If a taxpayer carries forward an NOL to a tax year after the NOL year, list the NOL deduction as a negative figure on the Other income line of Form 1040 or Form 1040NR (line 21 for 2013). Estates and trusts include an NOL deduction on Form 1041 with other deductions not subject to the 2% limit (line 15a for 2013). When a taxpayer carries forward an NOL, a statement must be attached to the return showing all the important facts about the NOL. The statement should include a computation as to how the NOL deduction was figured. If the taxpayer is deducting more than one NOL in the same year, your statement must cover each of them separately.

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59 If you carry two or more NOLs to a tax year, figure your modified taxable income by deducting the NOLs in the order in which they were incurred. First, deduct the NOL from the earliest year, then the NOL from the next earliest year, etc. After you deduct each NOL, there will be a new, smaller, modified taxable income to compare to any remaining NOL.

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61 All Subsequent Years

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63 Liz has 2014 NOL of $200,000 In 2012 filed MFJ They are now divorced Liz and Michael NOL is limited to her wages

64 1. Calculate the tax in the carryback year for each spouse as if they filed MFS. 2. Figure each spouse s percentage of the total tax from the two MFS returns. 3. Multiply the recomputed tax on the joint return after the NOL carryback by the taxpayer s percentage of the total MFS tax. 4. The result is the taxpayer s share of the joint tax liability.

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68 Married to Separate Returns Example 1 Example 2 Mark Nancy Income $50,000 $7,500 Expenses $11,500 $12,500 Net $38,500 -$5,000 Mark Nancy Total NOL $1,800 $3,000 $4,800 $5000 X ($1800/$4800) $5000 X ($3000/$4800) Shared NOL $1,875 $3,125 Mark and Nancy

69 MFS to MFJ Sam Wanda Totals NOL 2014 $18,000 $2,000 $20,000 MTI 2012 $15,000 $15,000 $0 $15,000 Carryover to 2013 $3,000 $2,000 $5,000 Step 1 - Separate 2014 Modified Taxable Income $9,000 $3,000 $12,000 Step 2 - Each Joint Share Modified Taxable Income 75% $11,250 $3,750 $15,000 Step 3 - NOL Deduction $2,000 $2,000 Sam and Wanda 2012: MFJ 2013: MFS 2014: MFS Step 4 - Joint MTI to Offset $11,250 $1,750 $13,000 Step 5 - Figure Carryover NOL $18,000 Joint MTI $13,000 Carryover $5,000 $0

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71 Pass-Through Entities Entity Decision: Gross Receipts Test Nature of Loss (special carryback years) Individual Decision: Carryback or Waive Carryback Decision A copy of K1 and any related calculations from NOL year should be attached to carry back and carry forward returns. Caution: Although the pass-through entity may generate NOLs for the partner or shareholder, the loss for any particular year may be limited by: Basis At-Risk Rules Passive Activity Rules. TC Dean vs. IRS lost because he could not prove 500 hours working in partnership

72 If line 21 is negative: + Charitable Contributions + Income Distributions + The exempt amount = NOL (or not) Positive Or Negative?

73 FINAL YEAR OF THE ESTATE OR TRUST Only on the final return of the estate or trust does any unused NOL flow to the beneficiaries. The instructions for Form 1041, Schedule K-1, Beneficiary s Share of Income, Deductions, Credits, etc., advise beneficiaries filing Form 1040 how to report the NOL on their returns. However, the preparer of Form 1041 must use the proper codes on the K-1 in order to apply the instructions correctly. Generally, an unused NOL from the current year and from any carryforward years is reported to the beneficiaries on the Schedule K-1 as a Code D on line 11, Final year deductions. For individual beneficiaries, these deductions flow to Form 1040, line 21. However, if the final year of the estate or trust is also the last year of the NOL carryforward period, the unused NOL is classified as an excess deduction and reported as a Code A on line 11 of Schedule K-1. Code A deductions flow to Form 1040, Schedule A, line 23 (miscellaneous itemized deductions subject to the 2% limitation).

74 Corporate Net Operating Losses (NOLs) A corporation generally figures and deducts a net operating loss (NOL) the same way an individual, estate, or trust does. The same 2-year carryback and up to 20-year carryforward periods apply, and the same sequence applies when the corporation carries two or more NOLs to the same year. For more information on these general rules, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts. A corporation s NOL generally differs from individual, estate, and trust NOLs in the following ways. 1. A corporation can take different deductions when figuring an NOL. 2. A corporation must make different modifications to its taxable income in the carryback or carryforward year when figuring how much of the NOL is used and how much is carried over to the next year. 3. A corporation uses different forms when claiming an NOL deduction. For more information, see the Instructions for Form 1139, and the instructions for the corporation s tax return.

75 The main differences between corporate and non-corporate NOLs are that corporations: Can t use the domestic production activities deduction to create or increase an NOL Can use the deduction for dividends paid on certain preferred stock of public utilities, without limiting it to its taxable income for the year Can take the deduction for dividends received, without regard to the aggregate limits that normally apply

76 In 2010, corporation A had $500,000 of gross income from business operations and $625,000 of allowable business expenses. It also received $150,000 in dividends from a U.S. corporation for which it can take an 80 percent deduction, which normally would be limited to 80 percent of its taxable income before the deduction. Income: Income $500,000 Dividends $150,000 Gross Income $650,000 Expenses $625,000 Net Profit / Loss $25,000 Dividends -$120,000 NOL -$95,000 If the special rule wasn t there, the corporation s deduction for the dividends-received would ve been $20,000, or 80 percent of its taxable income before the deduction ($25,000 x 80 percent)

77 Ownership change: A loss corporation (one with cumulative losses) that has an ownership change is limited on the taxable income it can offset by NOL carryforwards arising before the date of the ownership change. This limit applies to any year ending after the change of ownership.

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79 NOL Carryforward

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81 1. Is the return for the NOL year being filed timely? If not, the taxpayer cannot elect out of the carryback. 2. What is the proper carryback period? 3. What are the projected tax savings from carrying back the NOL? 4. Has the practitioner consulted with the taxpayer concerning future plans that might affect the projections? For example, does the taxpayer plan to get married or divorced? Will the business be liquidated? 5. What are the projected tax savings from electing out of the carryback period and carrying the NOL forward instead? If the tax rates and tax laws are scheduled to change significantly in the future, are these changes incorporated into the projection? 6. Has the taxpayer been fully informed of the choices? 7. If the taxpayer chooses to carry back the NOL, is it better to use Form 1045 or file amended returns for the carryback years? 8. If there is any NOL carryforward, is it clearly documented so that it will not be overlooked next year?

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