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Maximizing Net Operating Losses: Practical Guidelines & Strategies

Dive into understanding Net Operating Loss (NOL) rules, deductions, and computations. Learn how to optimize NOL for tax benefits and make informed decisions. Discover steps for NOL deduction and helpful worksheets.

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Maximizing Net Operating Losses: Practical Guidelines & Strategies

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  1. Net Operating Losses Chapter 2 pp. 39 - 70 2015 National Income Tax Workbook™

  2. AMAZINGLY SIMPLE HOME REMEDIES (That Really Work!) • 1.    AVOID CUTTING YOURSELF WHEN SLICING VEGETABLES BY GETTING SOMEONE ELSE TO HOLD THE VEGETABLES WHILE YOU SLICE. • 2. AVOID ARGUMENTS ABOUT LIFTING THE TOILET SEAT BY USING THE SINK. • 3. FOR HIGH BLOOD PRESSURE SUFFERERS ~ REDUCE PRESSURE BY CUTTING YOURSELF AND BLEEDING. REMEMBER TO USE A TIMER. • 4. A MOUSE TRAP PLACED ON TOP OF YOUR ALARM CLOCK WILL PREVENT YOU FROM GOING BACK TO SLEEP AFTER HITTING THE SNOOZE BUTTON. • 5. IF YOU HAVE A BAD COUGH, TAKE LAXATIVES.  THEN YOU'LL BE AFRAID TO COUGH. • 6. YOU ONLY NEED TWO TOOLS IN LIFE.  IF IT DOESN'T MOVE AND SHOULD, USE WD-40.  IF IT SHOULDN'T MOVE AND DOES, USE DUCT TAPE. • 7. IF YOU CAN'T FIX IT WITH A HAMMER, YOU'VE GOT AN ELECTRICAL PROBLEM. 

  3. Net Operating Losses Chapter 2 pp. 39 - 70 2015 National Income Tax Workbook™

  4. Net Operating Losses Page 39 • Steps for NOL Deduction. • NOL Carried between Joint and Separate returns • Special issues in NOL calculations • Making optimal use of an NOL deduction. • Appendix–Helpful NOL Worksheets

  5. Net Operating Losses Why understand NOL Rules and Comps? • There are decisions to be made that can impact the amount the client pays in taxes. • Do we carryback or forward? • Is it better to claim itemized deductions in loss year or delay payment to a CO year? What’s the difference? • Is it better to try to move income into or out of the loss year to or from a CO year?

  6. 23 VAC 10-110-84 Net operating loss carrybacks and carryovers. • Generally. For Virginia purposes a net operating loss deduction is allowed only to the extent that it is allowed in computing federal adjusted gross income. • Therefore, it must be carried back or carried forward to the same year as for federal income tax purposes

  7. Where to file NOL in VA • In the oval on the front of the return if the amended return is the result of a net operating loss (NOL) carryback. • General instructions for computing the NOL can be obtained from the website at www.policylibrary.tax.virginia.gov/OTP/policy.nsf. • Select 23VAC10-110-80 and 23VAC10-110-81 located in Chapter 110, Individual Income Tax, Virginia Tax Administrative Code.

  8. Net Operating Losses Page 39 • NOL Deductions can allow carrybacks of 2, 3, 5,or 10 years and carryforwards up to 20 years. • Idea simple but Calculations complex. • IRC Section 172 removes some tax benefits before an NOL deduction is calculated. • Income and deductions are modified in all affected years.

  9. Net Operating Losses Page 40 • Deductions for the NOL year are modified to determine the NOL that can be carried to other years. • Taxable income is modified in years to which the loss is carried to determine how much of the NOL is absorbed in each year.

  10. Net Operating Losses - Individual TaxpayersPage 40 Four Steps to Compute NOL Deductions for an Individual: • Determine eligibility • Compute the NOL • Distribute NOL to carryback & carryfoward years. • Re-Calculate taxes in carryback and carryforward years.

  11. Net Operating Losses - Individual TaxpayersPage 40 Step 1 - Determine Eligibility: • Individuals and C Corporations claim their own NOLs • Partnerships, S Corps and LLCs taxed as PS or S Corp: • Cannot claim their NOL deduction. • Partner, SH or member claim their share of the NOL deduction on their return.

  12. Net Operating Losses - Individual TaxpayersPage 40 Four steps to Compute NOL deductions for an Individual: • Determine eligibility • Compute the NOL • Distribute NOL to carryback & carryfoward years. • Calculate taxes in carryback and carryforward years.

  13. Net Operating Losses - Individual TaxpayersPages 40 - 41 Step 2 – Compute the NOL: • Negative taxable income is modified by removing deductions that are not allowed in computing the NOL. • Generally, only business losses are in an NOL & carried to another year. • Items with their own carryover rules are excluded from the NOL. • (Ex.: Capital Losses)

  14. Net Operating Losses - Individual TaxpayersPage 41 Exclude from NOL / Add back to Negative Taxable Income: • Dependents & personal exemptions. • Nonbusiness deductions in excess of nonbusiness income • Capital losses in excess of capital gains. • 50% exclusion of gain from Sec 1202 stock. • An NOL deduction carried from another year. • IRC domestic Production activities deduction. If sum of the above exceed negative taxable income, there is no NOL for the year.

  15. Net Operating Losses - Individual TaxpayersPage 41 Ex. 2.1 • Paige’s taxable Income for 2009 is ($10,000) • Nonbusiness deductions above nonbusiness income 6,000 • NOL ($4,000) • If non-business income had equaled or exceeded $10,000 there would be no NOL. • Business income & deductions arise from: • A trade or business, wages and (an exception for) casualty & theft losses even if personal.

  16. Observation p. 41 For NOL purposes: • Taxpayer prefers income and gain to be nonbusiness • Taxpayer prefers deductions and losses to be business

  17. Net Operating Losses - Individual TaxpayersPages 41 - 42 Ex 2.2

  18. Net Operating Losses – Other Ways to Look At ItPage 42 Observation

  19. Net Operating Losses - Individual TaxpayersPage 42 • Farm & Fishing Income Averaging - • See pages 371 – 375 of the 2009 text. • Suspended losses from passive activities, at-risk rules, basis limits, contributions: • Do not impact NOL computation in years suspended because not deducted in these years. • Do go into NOL computation in year they are allowed.

  20. Net Operating Losses - Individual TaxpayersPage 42 • Form 1045 – Application for Tentative Refund • Schedule A – A worksheet for computing NOL for Form 1045 or an amended return. • Appendix to this Chapter, pages 65 – 70, include help to complete Form 1045 via 4 worksheets: • #1 – Nonbusiness and business capital losses • #2 – Nonbusiness and business capital gains • #3 – Nonbusiness deductions • #4 – Nonbusiness income

  21. Net Operating Losses - Individual TaxpayersPages 42 - 43 Four steps to Compute NOL deductions for an Individual: • Determine eligibility • Compute the NOL • Distribute NOL to carryback & carryfoward years. • Calculate taxes in carryback and carryforward years.

  22. Net Operating Losses - Individual TaxpayersPages 42 - 43 Step 3 -- Distribute the NOL • Different carryback periods based on source of NOL. • NOL absorbed in carryover year is modified taxable income NOT taxable income in carryover year. • Thus do not get full benefit of the NOL carryover. • Can elect to forgo carryback for a carryforward: • Election on original return for NOL year or • Amended return for NOL year filed within 6-months of original return due date.

  23. Net Operating Losses - Individual TaxpayersPages 43 - 44 • General Rule – Carryback 2 years and then forward for 20 years. • Any loss not used up is lost. • Exceptions – NOL from Casualty, Theft & Small Business Disaster Losses have 3-Year carryback and Farm losses have a 5-year carryback. • Must allocate if have 2 and 3 year carryback losses – As though have two separate NOLs • IRS does not provide rules on how to allocate between NOLs with different carrybacks but IRC 172(b)9(1)E(ii) does provide guidance.

  24. Net Operating Losses - Individual TaxpayersPage 44 EX. 2.3 • Cherry had a $700 theft loss in 2015. • She claimed a $6,300 Standard Deduction. • Her Itemized Deductions were $4,500 (excluding the theft loss) • She had a $10,000 business loss. • Her only investment income was $500. What’s her NOL? Can she carryback her theft loss?

  25. Net Operating Losses - Individual TaxpayersPage 44 EX 2.3 No theft loss carryover since it did not affect her NOL and Carryover period is 2-years….NOT 3..

  26. Net Operating Losses - Individual TaxpayersPages 44 - 45 EX 2.4 • Suppose Cherry’s theft loss had been $50,000 instead of $700? • She would itemize because of that theft loss. Now what’s her NOL? Can she carryback her theft loss? How much of her NOL has a 2 yr CB? How much of her NOL has a 3 yr CB?

  27. Net Operating Losses - Individual TaxpayersPages 44 - 45 EX 2.4

  28. Net Operating Losses - Individual TaxpayersPages 44 - 45 EX 2.4 • Bus Inc ($10,000) • Invest Income 500 • AGI ($ 9,500) • Personal Exemption ( 4,000) • Deductible Casualty ( 49,900) $49,900* • Other Itemized Deducts ( 4,500)* • Taxable Income ($67,900) • Add Back: Exemp 4,000 • Item Deds – Invest Inc 4,000 • NOL ($59,900)( 59,900) • NOL over Casualty – 2 year carryback = $10,000 • $49,900* Casualty Loss NOL - 3 year carryback

  29. Net Operating Losses - Individual TaxpayersPage 45 Another Exception to 2 Year Carryback Small Business Disaster Losses – 3 Year Carryback • These are losses from “Federally Declared Disasters”. • Must allocate NOL between 2 year and 3 year CBs if have both types. • Three possible methods of NOL allocation: • Allocate to 3-year CB 1st • Allocate to 2-year CB 1st • Allocate based on pro rata basis

  30. Net Operating Losses - Individual TaxpayersPages 45 - 46 Ex 2.5 • Doug’s store destroyed by flood . • Area declared a “Federal Disaster Area” • Doug suffered a $70,000 loss from being closed • Doug’s wife earned $20,000 teaching • Doug’s wife suffered a $30,000 loss from her internet business How much of the NOLs can be carried back 2 years? How much of the NOLs can be carried back 3 years?

  31. Net Operating Losses - Individual TaxpayersPages 45 - 46 Ex 2.5 • Wages $20,000 • Taxable interest 5,500 • Doug’s store loss (70,000) 3-Year CB • Wife’s business loss (30,000) 2-Year CB • AGI $ ( 74,500) • Standard Deduction ( 12,600) • Personal exemption ( 8,000) • Taxable income $ (95,100) • Add back: Stand. Ded. 5,900 = 12,600 – 5,500 Inv Inc • Pers. Exem. 8,000 • NOL $ (80,000) 3 ways to allocate NOL between 2 and 3 year CB periods

  32. Net Operating Losses - Individual TaxpayersPages 45 - 46 Ex 2.5 and Fig 2.5 • $ 70,000 3-Year CB for Federal Disaster Area • $ 30,000 2-Year CB from a regular business loss • $100,000 total in losses • But, due to adjustments NOL is only $80,000 • Method 3-Year CB2-Year CB • 1st allocate to $70,000 $70,000 $10,000 • 1st allocate to $30,000 $50,000 $30,000 • Pro-rata allocation: 70,000 / 100,000 x 80,000 = $56,000 $24,000

  33. Net Operating Losses - Individual TaxpayersPage 46 Ex 2.6 Priority of CBs and CFs -- 2-year CBs are used first If allocation Method # 1 were used: 2012 2013 2014 2015 2016 • 3 Yr NOL CB (70,000) • 2 Yr NOL CB (10,000) • (70,000) 1st 2nd 2nd 2nd • (10,000) 1st 1st 1st If elect to forgo CB the election to forego a CB applies to both CBs.

  34. Net Operating Losses - Individual TaxpayersPages 46 - 47 Another Exception to 2 Year Carryback Farming Losses including nurseries, sod farms, etc – 5 Year Carryback & 20 Year Carryforward • Farming Loss is defined as lesser of: • NOL from income and deductions from farming • Total NOL • NOLs are 1st allocated to farming losses and then to other losses

  35. Net Operating Losses - Individual TaxpayersPage 47 EX 2.7, Fig. 2.6 • Wages $20,000 • Taxable interest 5,500 ($ 5,500) • Farming bus. loss - 5-year CB ( 70,000) ($70,000) • Truck bus. loss (Fed Disaster) ( 30,000) • AGI ($ 74,500) • Standard Deduction ( 12,600) 12,600 • Personal Exemption ( 8,000) • Taxable income ($ 95,100) • Add Back: Excess Stand. Ded. $12,600 – 5,500 (non-bus inc) 7,100 $ 7,100 • Pers. Exemp. 8,000 • Total NOL $( 80,000) ($80,000) • Remaining NOL – 3-year CB ($10,000)

  36. Net Operating Losses - Individual TaxpayersPage 47 EX 2.7 Q&A # 1: What is the NOL computed using only Sandy’s farm income? Q&A # 2: What is the NOL if Rocky’s wages were $35,000 instead of $20,000?

  37. Net Operating Losses - Individual TaxpayersPage 47 EX 2.7, Q1 Q&A # 1: Sandy’s NOL from farming only is $70,000 and has a 5-year CB since from farming. The $10,000 NOL from a small business disaster loss has a 3-year CB. • Farming NOL = $70,000 5-year CB Farming • Total NOL = $80,000 • Remaining NOL = $10,000 3-year CB Federal Disaster Area

  38. Net Operating Losses - Individual TaxpayersPage 47 EX 2.7, Q2 • Wages changed to - $35,000 • Taxable interest 5,500 ($ 5,500) • Farming business loss ( 70,000) ($70,000) • Truck business loss (FDA) ( 30,000) • AGI $( 59,500) • Standard Deduction ( 12,600) 12,600 • Personal Exemption ( 8,000) • Taxable income $( 80,100) • Add Back: Stand. Ded. 7,100 $ 7,100 • Pers. Exemp. 8,000 • Total NOL $( 65,000)($65,000) • Continued……..

  39. Net Operating Losses - Individual TaxpayersPages 47 - 48 EX 2.7, Q2 • Farming NOL = $70,000 But limited to total NOL • Total NOL = $65,000 5-year CB Farming • Remaining NOL= $ -0- 3-year CB Fed Disaster Area • If waive 5-year farming CB it reverts to a 2-year CB

  40. Net Operating Losses - Individual TaxpayersPage 48 Other Exceptions to 2 Year Carryback • Specified Liability Loss – 10-year CB • NOL attributable to Product Liability loss or • Reclamation of land • Decommissioning of nuclear power plant • Dismantling a drilling platform • Remediation of environmental contamination • Payment under worker compensation act • Certain Disaster AREA losses – 5-year CB • Qualified Disaster Loss – 2008 and 2009 • Qualified GO Zone; Kansas Area; Midwestern Area • If elect to waive 10-year CB the CB is 2-years.

  41. Net Operating Losses - Individual TaxpayersPage 48 • Election to forgo any carryback requires attaching a statement to the original return for the loss year. • Election must be made on: • Original return including extensions or • Amended return filed within 6-months of unextended due date. • If no election is made the NOL is absorbed in the CB years even if no NOL is carried to those years….See Ex 2.9

  42. Net Operating Losses - Individual TaxpayersPage 49 • NOL Absorption -- NOL Minus Modified Taxable Income in each intervening year…..Use Schedule B, Form 1045 • Modified taxable income = • Taxable Income in the Intervening Year • Less: • Capital Losses deducted in excess of capital gains • Partial exclusion on gain on qualified small business stock • Personal & dependent exemptions • D omestic production activities deduction

  43. Net Operating Losses - Individual TaxpayersPage 49 • Adjustments to compute Modified Taxable Income change AGI which also affects: • Special allowance for passive losses from rental property • Taxable Social Security benefits • IRA Deductions • Excludible savings bond interest • Exclusion amounts rec’d under employer adoption program • Student loan interest • Tuition and fees deduction • Itemized Deductions impacted by a change in AGI. Enter these adjustments on Line 6, Schedule B Form 1045

  44. Net Operating Losses - Individual TaxpayersPage 50 Four steps to Compute NOL deductions for an Individual: • Determine eligibility • Compute the NOL • Distribute NOL to carryback & carryfoward years. • Calculate taxes in carryback and carryforward years.

  45. Net Operating Losses - Individual TaxpayersPage 50 Step 4 – Calculate Taxes in CB and CF Years: • An NOL carryback: • Reduces AGI and Taxable Income which can affect itemized deductions and exemptions. • Changes are reported on Form 1045 or an amended return. • An NOL carryfoward: • Shown as negative income on Line 21, Form 1040 (“Other Income”)

  46. Net Operating Losses - Individual TaxpayersPage 50 • Deadline for Form 1045 • Before end of tax year following year of NOL. • Not before return for NOL year is filed. • Example -- Form 1045 for 2015 can be filed • after 2015 return is filed and before • the end of 2016. • Deadline for Form 1040X • 3-years from due date of loss year return. • Example -- Form 1040X for 2015 must be filed • by 4/15/2019 unless there was an • extension to file the 2015 return.

  47. Net Operating Losses - Individual TaxpayersPages 50 - 51 • Change in filing status requires allocations. • Allocation of a Joint NOL: • Allocate to each spouse their share of NOL as if a separate return had been filed. • Computation = Each spouse’s NOL on a separate return divided by total of NOL’s both spouses would have had on separate returns is allocated to each spouse. • If only one spouse had an NOL all of the joint return NOL is allocated to that spouse.

  48. Net Operating Losses - Individual TaxpayersPage 51 Ex 2.10 • Joint NOLNOLs if filed Separate • Total Joint NOL $10,000 • Husband’s NOL $ 9,000 • Wife’s NOL 3,000 • Total NOL if filed separately $12,000 Allocation: Husband’s NOL = $10,000 x 9,000/12,000 = $ 7,500. Wife’s NOL = $10,000 x 3,000/12,000 = $ 2,500. Total of Allocated Joint NOL $10,000

  49. Net Operating Losses - Individual TaxpayersPage 51 Ex 2.11 • Joint NOLNOLs if filed Separate • Total Joint NOL $10,000 • Husband’s NOL $ 9,000 • Wife’s NOL 3,000 • Total NOL if filed separately $12,000 Allocation: Husband’s NOL = $10,000 x 9,000/12,000 = $ 7,500. Wife’s NOL = $10,000 x 3,000/12,000 = $ 2,500. Total of Allocated Joint NOL $10,000 But, now let’s suppose only one of the spouses filing a joint return had an NOL……….

  50. Net Operating Losses – Only One with NOLPage 51 Ex 2.11 • Joint NOLNOLs if filed Separate • Total Joint NOL $4,000 • Husband’s NOL $ 7,000 • Wife’s NOL -0- • Total NOL if filed separately $ 7,000 Allocation: Husband’s NOL = $ 4,000 Wife’s NOL = -0- Total of Allocated Joint NOL $ 4,000

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