•Unemployment compensation. IRS publications and instructions do not address whether unemployment compensation is
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 states: “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.
Exception to 2-year carryback rule. If the NOL is due to a farming loss, the carryback period is five years. A taxpayer can waive
the 5-year carryback period and instead use the 2-year carryback
period.
Disaster areas. A 5-year carryback period applies to NOLs
occurring as a result of a federally declared disaster loss.
Qualified disaster loss is the lesser of:
•The sum of:
–Losses allowable as a casualty loss for the tax year attributable to a federally disaster occurring in 2008 or 2009 in a disaster area, and
–The deduction for qualified disaster expenses allowable under IRC §198A(a) or that would be allowable if not otherwise treated as an expense.
•The NOL loss for the tax year.
Taxpayers entitled to a 5-year carryback may elect to use the
2‑year carryback period. The election is irrevocable and must be
made by the due date, including extensions for the tax year of the
NOL. A loss deduction under these rules also offsets AMT.
Midwestern disaster area. IRC Section 1400N(k) rules for Gulf Opportunity Zone loss are extended to the Midwestern disaster
area.
See IRS Pub. 4492-A, Kansas Storms and Tornadoes, and IRS Pub.
4492-B, Midwestern Disaster Area, for more information.
Where to enter the NOL in a carryback or carryforward year.
An NOL is always entered as a negative number on the other
income line, Form 1040 (line 21 for 2008). An NOL carryback or
carryforward cannot be used to increase an NOL for the carryback or carryforward year. It also does not affect the SE tax calculation for a carryback or carryforward year. Use Form 1045 or
Form 1040X to carry the NOL back. Simply enter the NOL in the
following year on the other income line for a carryforward year.
Attach a statement to the return showing the NOL computation
for each NOL being carried to that year.
How to Calculate an NOL Carryforward
To prevent an NOL from causing a double deduction, the amount of
an NOL that is not used up in the initial carryback or carryforward
year must be adjusted before it can be used again in the following
year. The adjustment to the unused NOL is calculated by modifying
the AGI for the year the NOL was carried to. The following income
and deductions must be refigured to determine modified AGI:
•The special allowance for passive activity losses from rental real
estate activities.
•Taxable Social Security benefits.
•IRA deduction for an active participant in an employer plan.
•Excludable savings bond interest.
•The exclusion of amounts received under an employer’s
adoption assistance program.
•The student loan interest deduction.
•The tuition and fees deduction.
The following itemized deductions are refigured using modified AGI for NOL purposes:
•Medical expenses.
•Charitable contributions.
•Casualty and theft losses.
•Miscellaneous itemized deductions subject to the 2% AGI limitation.
Once items of income and deductions are refigured using modified AGI, the amount of the NOL that is considered to have been
used up can be calculated. Use Schedule B, Form 1045, to determine the NOL deduction for each carryback year and the amount
to be carried forward, if not fully absorbed in the year it is first
carried to. Use the worksheet in the Form 1045 instructions if
itemized deductions are limited in a carryback or carryforward
year. Use Schedule B, Form 1045, as a worksheet to calculate the
unused NOL, even if Form 1045 is not being used to carry the
initial NOL back.
For 2008, 3,4,&5 year carryback allowed by election for small businesses with under $15 million gross receipts.
8-16 Business Deductions
TheTaxBook™ — 2008 Tax Year