Transcript Powerpoint file

Net Operating Losses of
Individuals
BUS 225K
Professor Nellen
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Agenda
Relevance
Basic definitions
Rationale
History
§172 Overview
Mechanics – calculation and c/o
State tax considerations
Policy perspectives
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Relevance
Can enable taxpayers to maximize use of
deductions and losses – not limited to a single
year perspective
Planning considerations
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If individual might have NOL, consider moving items
that don’t go into an NOL into another year if possible.
Carryback or only forward
State income tax treatment
What is approaching end of c/f period and still have
large NOL/
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Basic definitions
NOL – what arises in a year if certain
losses and deductions exceed one’s
income.
NOLD – the deduction you can take in
another year because of an NOL
Carryover – an NOL is generally allowed
to be carried back and then forward. The
length of any carryback and carryforward
period has changed over time.
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Rationale
To ameliorate the effect of an annual accounting
period.
To “recognize the exigencies of business.”
Improve equity and fairness – some businesses
may have less steady business cycles than
others.
The calculation rules vary for corporations and
other taxpayers.
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Generally, the rules are easier for corporations.
Congress does not find that certain personal or sometimes
non-cash deductions of individuals should generate an NOL,
but that instead, for such deductions, each year should stand
on its own.
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Why allow a carryback?
Because past or future income/profits
must cover the NOL, both a carryback and
carryforward period are justified. In
contrast to a carryfoward, a carryback has
the advantage of better recognizing the
time value of money.
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History - 1
Originally, calculation of NOL took an
economic income approach, changing to a
taxable income approach with IRC of 1939
(Callanan Road Improvement, 404 F2d
1119 (2nd Cir. 1968)).
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History - 2
Revenue Act of 1918 –first time NOL c/o allowed
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c/b 1 year and then forward 1 year.
Ending of WWI = expectation of business losses (The Yale Law Journal,
April 1932, p. 900).
The “net loss” had to result from either a business regularly carried on or
bona fide sale of assets acquired after April 5, 1917 for production of war
items.
Loss was equal to allowable deductions over gross income plus tax-exempt
interest income.
NOL carryforward extended by later tax acts but omitted in National
Industrial Recovery Act of 1933.
1939 - 2-year carryforward enacted.
1942 - 2-year carryback added (Appleby, 116 FSupp 410 (Ct. Cl.
1953)).
Later - various changes made including wrt types of losses covered
and carryover periods.
Today, §172 generally allows NOL to be carried back 2 years and
then forward 20 years (prior to this change by Taxpayer Relief Act of
1997 (PL 105-34; 8/5/97) periods were 3 and 15, respectively).
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§172 Overview
Need to calculate the NOL
Carry it back 2 years (generally) unless timely
elect to forego c/b period (§172(b)(3))
In any year, could have both a c/b and a c/f to
that year. The total of these amounts is the
NOLD.
Need recordkeeping to track NOL – for both
regular tax and AMT purposes.
Many special rules included in §172 for certain
entities or types of losses
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§172 Mechanics
“(a) Deduction allowed. There shall be
allowed as a deduction for the taxable
year an amount equal to the aggregate of
(1) the net operating loss carryovers to
such year, plus (2) the net operating loss
carrybacks to such year. For purposes of
this subtitle, the term “net operating loss
deduction” means the deduction allowed
by this subsection.”
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NOL Defined
Ҥ172(c) Net operating loss defined.
For purposes of this section, the term “net
operating loss” means the excess of the
deductions allowed by this chapter over
the gross income. Such excess shall be
computed with the modifications specified
in subsection (d).”
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Modifications for Individuals
Add back to negative taxable income:
Any NOLD
Excess of capital losses over capital gains
QSBS gain exclusion of §1202 allowed
Personal exemptions
Excess of nonbusiness deductions over nonbusiness income
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G/L from disposition of business property subject to depreciation and real property used in trade or business
are considered business income and deductions
Treat personal casualty losses are business (so can generate an NOL)
Charitable contributions considered non-business.
Alimony paid = non-business (Monfore, TCM 1988-197)
§404 deductions (deferred comp plans) of an EE = nonbusiness
State income taxes attributable to Schedule C business = business
Deductible moving expenses = business (Rev Rul. 72-195)
Employee business expenses = business
Employee wages = business (1.172-3)
Rental of a residence = business (Lagreide, 23 TC 508 (1954))
Standard deduction = nonbusiness
Manufacturing deduction of §199
[§172(d), 1.172-3 and various court cases, IRS rulings, Schedule A of Form 1045, nice summary in
IRS Pub 536]
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Example from Pub 536
Excess of deductions
over income =
$11,300
To determine NOL
that can be c/b, need
to apply 172(d)
modifications to
$11,300
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Example - continued
Excess ded over income
Modifications:
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Personal exemptions
STCL (non-business)
Excess non-business deductions
($5,450) over non-business
income ($425)
NOL to c/b or c/f
(11,300)
3,500
1,000
5,025
$1,775
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What to do with NOL
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Attach statement to timely filed return (including
extensions) electing to forego c/b period (§172(b)(3))
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Generally no revocable
Also applies to AMT NOL (Rev Rul 87-44)
File amended returns for prior years (carryback to
earliest year first)
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Must file within 3 years of the filing date (incl extension) for the
NOL return)
Refigure prior year TI (will be adjustments to AGI based
figures except charitable contributions (§170(d) and 1.170A10(d)) and SE tax (§1402(a)(4))
File Form 1045, Application for Tentative Refund
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IRC §6411 must file within 1 year after end of NOL year
Complete the worksheets to figure refund
IRS to process form within 90 days
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Questions
1. Will a passive activity loss increase an NOL?
2. Bob had NOL in 2009 and wants to carry it
back using Form 1045. What is deadline to file
that form?
3. If Bob’s 2009 return is audited by IRS, can they
also adjust his 2007 and 2008 returns if they
find an error with the NOL (and he carried it
back)?
4. If it looks like the Smiths will have an NOL for
current year, what planning advice should you
give them?
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Example
Does Abigail have NOL for 2007?
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Wages
Interest income
Schedule C
Schedule A
Personal exemp
Capital gain
TI
$30,000
100
(45,000)
(12,000)
( 3,400)
1,500
(28,800)
(incl $2K casualty)
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State tax considerations
States might not conform to federal calculation
and c/o rules.
CA 2008 law change – suspend NOL for large
t/p for 2008 and 2009 to help address budget
shortfall. Also conformed the c/b and c/f periods
to match federal (starting in 2011).
NJ 2008 – extended corporate NOL c/f from 7 to
20 to help state’s business climate.
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Policy perspectives
Loophole?
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Sometimes c/o referred to such by lawmakers and
others
What is appropriate c/b and c/f period?
Time value of money
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Some recognition wrt carrybacks, but not
carryfowards
Should c/f amounts be increased for an interest
factor?
Flat tax promoted by Drs. Hall and Rabushka allows:
Unlimited carryforward of the excess of deductions over
income (The Flat Tax, pg 216).
Carryforward increased by an interest factor to recognize
time value of money of postponed deductions.
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Summary
NOL exists for fairness, ameliorate effect of annual
accounting period.
But, for individuals, not all expenditures or losses create
an NOL, so planning is important, where possible.
3 possibilities if have NOL, planning important including
consideration of rate in past and in future
Recordkeeping important
If not sure if something goes into NOL, research it. Lots
of guidance accumulated over the years.
Watch out for possible federal and state changes,
particularly state.
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