Download Net Operating Loss (NOL)

not allowed. Any insurance or other reimbursement received for
the lost inventory is reported as taxable income.
If the casualty loss is due to a Presidentially declared disaster, the
taxpayer can choose to deduct the loss as a casualty loss on the
return for the immediately preceding year. If the taxpayer chooses this approach, decrease opening inventory for the year of the
loss so the loss will not show up again in inventory.
Net Operating Loss (NOL)
Cross References
•Form 1045, Application for Tentative Refund
•IRS Pub. 536, Net Operating Losses (NOLs)
for Individuals, Estates, and Trusts
•IRC §172
Related Topics
•Disaster areas NOLS, page 8-16, 1040 Edition
•NOLs for C corporations, page SB2-11
•NOL business/nonbusiness allocation worksheet, page SB15-8
What is a Net Operating Loss (NOL)?
An individual, estate, or trust may have an NOL if deductions
for the year exceed income. NOLs are caused by losses from the
following:
•Trade or businesses (Schedules C and F losses, or K-1 losses
from partnerships or S corporations),
•Deductions for work as an employee (Form 2106),
•Casualty and theft losses (whether personal or business),
•Moving expenses, and
•Rental property (Schedule E).
Individual NOL. An individual may have an NOL if AGI minus the standard deduction or itemized deductions is a negative
amount, and the negative amount is due to business deductions
exceeding business income.
Estate or trust NOL. An estate or trust may have an NOL if the
taxable income line on Form 1041 is a negative amount, and the
negative amount is due to business deductions exceeding business
income.
How to Calculate an NOL
The following instructions apply to individuals (Form 1040). For
estates and trusts filing Form 1041, see Pub. 536.
Step one. Complete the tax return for the current year. If line 41
for the 2008 Form 1040 is not a negative amount, stop here, there
is no NOL.
Step two. Separate business income and deductions from nonbusiness income and deductions. Use the NOL business/nonbusiness allocation worksheet, page SB15-8. For items that are
not specifically identified as business or nonbusiness, allocate as
follows:
•State refund. The taxable state refund must be allocated between the portion that represents state income tax on nonbusiness income and tax on business profits.
•Schedule E gain or loss. Business gains and losses from Schedule E include rental activities and the business share of K-1
pass-through items from partnerships and S corporations. Nonbusiness gains and losses from Schedule E include the nonbusiness share of K-1 pass-through items from partnerships and
S corporations.
•Unemployment compensation. IRS publications and instructions do not comment on unemployment compensation as to
whether it is a business or nonbusiness source income for NOL
purposes.
Author’s Comment: This author has had mixed results from IRS
service centers. One called unemployment compensation nonbusiness
until we wrote back with a page from a University of Minnesota tax
course book that identified it as business source income.
•Other income. Do not allocate an NOL carryforward or carryback from another year to either nonbusiness or business gain
or loss. Most other income items are allocated to nonbusiness.
Jury duty pay would be an example of business income.
•Capital gains and losses. Most capital gains and losses are
nonbusiness. An example of a business capital gain would be
the Section 1231 gain in excess of depreciation recapture on the
sale of property used in a trade or business.
•Other AGI adjustments to income. Most other AGI adjustments to income are nonbusiness. Jury duty pay given to the
employer, if included as other income, would be an example of
a business deduction.
•State income tax paid. The deduction on Schedule A must be
allocated between the portion that represents tax on nonbusiness income and tax on business profits.
•Miscellaneous itemized deductions. Unreimbursed employee
business expenses such as union dues, uniforms, tools, education expenses, travel and entertainment, and business vehicle
expenses are all business deductions. Impairment-related work
expenses are business deductions. The unrecovered investment
in a pension or annuity claimed on a decedent’s final return
is a business deduction. Investment expenses are nonbusiness
deductions. The nonbusiness portion of tax preparation fees is
a nonbusiness deduction.
Step three. Once nonbusiness income and deductions are separated from business income and deductions, use these amounts
to fill out Schedule A, Form 1045. Schedule A calculates the NOL
for the current tax year. Form 1045 is used to carry an NOL back
if the form is filed within one year after the end of the year in
which an NOL arose. If a return is filed later than one year after
the NOL year, use Form 1040X to carryback the NOL. Schedule A,
Form 1045, can still be used as a worksheet to calculate the NOL,
even if Form 1045 is not filed to carry the NOL back, or the taxpayer elects to carryforward the NOL.
How to Use an NOL
Once the NOL has been calculated for the year, it is used to offset
income from another tax year. The default is to carry the NOL
back two years. If the NOL is not used up in that year, it is carried
forward to the following year. If not used up in that year, it continues to be carried forward until it is used up. The longest it can
be carried forward is 20 years after the NOL year.
Election to waive the carryback years. A taxpayer can elect to
not carry the NOL back, but only carry the NOL forward. To make
this election, attach a statement to the return that says: “The taxpayer hereby elects under Section 172(b)(3) of the Internal Revenue Code to waive the net operating loss carryback period.”The
election must be made on an original return filed by the due date
(including extensions). If the taxpayer fails to file the return on
time with this election, the taxpayer must carry the NOL back
under the carryback rules, even if no benefit is derived by carrying the NOL back.
Exceptions to 2-year carryback rule. If the NOL is due to a casualty or theft, or attributable to a Presidentially declared disaster for a qualified small business, the carryback period is three
years. If the NOL is due to a farming loss, the carryback period
is five years.
Election not to carry a farm loss back five years. A taxpayer
can waive the 5-year carryback period and instead use the 2‑year
carryback period. To make this election, attach a statement to
For 2008, 3,4,&5
year
allowed by election for small businesses under $15 million gross receipts.
TheTaxBook™ — 2008
Tax carryback
Year
Business Deductions SB8-7