Federal Tax

Net Operating Losses — Concepts and Computations (Portfolio 539)

Tax Management Portfolio, Net Operating Losses — Concepts and Computations, No. 539, describes and illustrates the tax principles for using a net operating loss sustained by a taxpayer as a net operating loss deduction under §172.

Description

Tax Management Portfolio, Net Operating Losses — Concepts and Computations, No. 539, describes and illustrates the tax principles for using a net operating loss sustained by a taxpayer as a net operating loss deduction under §172. The net operating loss deduction allows a taxpayer with a loss in one taxable year to carry the loss back or forward to offset taxable income of earlier or later taxable years. By permitting taxpayers to offset profitable years with loss years, the deduction minimizes the disparity that would otherwise result between businesses with stable incomes and businesses with fluctuating incomes due to use of an annual accounting period.

After briefly examining the background and rationale of §172 and providing an overview of the deduction, this Portfolio points out that most taxpayers are eligible to deduct net operating losses and examines the eligibility restrictions. The Portfolio then furnishes a step-by-step explanation of the computations required in applying §172, including: (1) the computation of a net operating loss; (2) the determination of the carryback and carryover periods, including the temporary carryback periods applicable to disaster losses; (3) the computation of the amount of net operating loss carrybacks and carryovers; and (4) the computation of the net operating loss deduction. Procedural aspects of claiming the deduction are also examined. The Portfolio describes the alternative minimum tax net operating loss deduction, which replaces the deduction under §172 for alternative minimum tax purposes.

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DETAILED ANALYSIS —

I. Introduction

A. Purpose of the Deduction

B. Overview of the Deduction

C. Judicial Construction of §172

D. State Laws

II. Eligible Taxpayers

A. Taxpayers Eligible to Deduct Net Operating Losses

1. Individuals

2. C Corporations

3. Estates and Trusts

4. Exempt Organizations

5. Non-Life Insurance Companies

B. Restrictions on the Deduction of Net Operating Losses

1. Partnerships

a. Treatment at Partnership Level

b. Deduction by Partners

2. S Corporations

a. Losses Pass Through to Shareholders

b. Deduction of Losses Limited to Shareholder’s Basis

(1) In General

(2) Economic Outlay Required for Debt Basis

(3) Treatment of Open Account Debt

c. Carryover of Disallowed Losses

(1) In General

(2) Transfers Involving Spouses

(3) Last Taxable Year of S Corporation

d. Conversion of C Corporation to S Corporation

3. Life Insurance Companies

4. Regulated Investment Companies

5. Corporations Subject to Accumulated Earnings Tax

6. Personal Holding Companies

7. Cooperative Organizations

8. Membership Organizations

9. Reorganizations Involving Loss Corporations

a. Carryover in Liquidations of Subsidiaries and Certain Reorganizations

b. Section 382 Limitation

c. Acquisitions to Evade Taxation

C. Deduction Allowed to Taxpayer Who Sustained the Loss

1. General Rule

2. Estates and Trusts

a. Net Operating Losses of Decedents

b. Net Operating Losses of Ongoing Estates and Trusts

c. Net Operating Losses of Terminating Estates and Trusts

(1) Deducting Unused Loss Carryovers

(2) Deducting Excess of Deductions Over Income

(3) Section 642(h)(1) vs. §642(h)(2)

(4) Beneficiaries Succeeding to the Property of the Estate or Trust

3. Corporations

a. Net Operating Losses of Corporations Generally

b. Net Operating Losses of Corporations That Dissolve

c. Changes in Form of Business

4. Termination of Disputed Ownership Funds

III. Determining the Existence of a Net Operating Loss

A. Introduction

1. Net Operating Loss Defined

2. What Constitutes a Loss

3. Role of the Modifications

4. Limitation on Excess Business Losses Under §461(l)

B. Corporations

1. General Rule

2. Modifications

a. Disallowance of Net Operating Loss Deduction

b. Modification of Dividends Received Deductions

(1) Tax Years Beginning After December 31, 2017

(a) Dividends Received Deductions Under §243, §245, and §245A

(b) Aggregate Limitation

(d) Modification Under §172(d)(5) and Aggregate Limitation

(2) Tax Years Beginning Before January 1, 2018

(a) Dividends Received Deductions Under §243 and §245

(b) Aggregate Limitation

(d) Modification Under §172(d)(5) and Aggregate Limitation

(3) Coordination of Net Operating Loss Rules, the Dividends Received Deduction, and the Percentage Depletion Deduction

(4) Planning Considerations

c. Disallowance of Domestic Production Activities Deduction Under Former §199

d. Disallowance of Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI) Under §250

C. Taxpayers Other Than Corporations

1. General Rule

2. Modifications

a. Net Operating Loss Deduction

b. Personal Exemption Deduction

c. Limitations on Deduction of Nonbusiness and Business Capital Losses and Ordinary Nonbusiness and Business Deductions

(1) Threshold Issues in Determining Existence of Net Operating Loss

(a) Attributable to or Derived from a Trade or Business

(i) “Trade or Business” Defined

(A) In General

(B) Employment as a Trade or Business

(ii) “Attributable To” or “Derived From”

(A) Nature of Relationship Required

(B) Interest on Tax Deficiencies

(D) Embezzlement Not Attributable to Employment

(iii) Timing Considerations

(A) Preparatory Activities

(B) Income From a Terminated Trade or Business

(iv) Trade or Business Distinguished From Investment

(A) Transactions Between Corporations and Shareholders

(B) Real Estate Transactions

(D) Oil and Gas Transactions

(v) Multiple Trades or Businesses

(b) Business and Nonbusiness Income and Deductions

(i) Business Income

(ii) Nonbusiness Income

(iii) Business Deductions

(iv) Nonbusiness Deductions

(i) Deduction of Capital Losses Generally

(ii) Distinction Between Business and Nonbusiness Capital Gains and Losses

(iii) Required Allocation for Capital Loss Carryovers

(2) Limitations

(a) Nonbusiness Capital Losses

(b) Nonbusiness Deductions

(i) Rules for Applying Limitation

(ii) Examples

(iii) Impact of Nonbusiness Deductions on Net Operating Loss

d. Disallowance of Exclusion for Certain Capital Gains Under §1202

e. Disallowance of Domestic Production Activities Deduction Under §199

f. Disallowance of Qualified Business Income Deduction Under §199A

3. Comprehensive Examples Involving Modifications

D. Special Rules

1. Real Estate Investment Trusts

a. Modification for §857(b)(2) Adjustments

b. Treatment of Capital Gain Dividends

2. Exempt Organizations

3. Public Utilities

a. No Modification on or After December 19, 2014

b. Modification Prior to December 19, 2014

(1) Dividends Paid Deduction Under Pre-2014 TIPA §247

(2) Modification Under Pre-2014 TIPA §172(d)(5)

4. Estates and Trusts

E. Determining Law Applicable to Previous Tax Years

1. Net Operating Loss Determined Using Law of Loss Year

2. Case Law and Rationale

IV. Carryback and Carryover Periods

A. General Rule

1. Net Operating Losses Arising in Tax Years Beginning After December 31, 2017 And Before January 1, 2021

2. Net Operating Losses Arising in Tax Years Beginning After December 31, 2020

3. Net Operating Losses Arising in Tax Years Beginning Before January 1, 2018

a. Carryback Period

b. Carryover Period

4. No Extensions Granted

5. Treatment of Short Taxable Years

a. Short Year in Carryback or Carryover Period

b. Loss Generated in Short Year

6. Special Applications

a. Effect of Conversion by C Corporation to S Corporation

b. Exempt Organizations

B. Exceptions to General Carryback Period

1. Net Operating Losses Arising in Tax Years Beginning After December 31, 2017 and before January 1, 2021

a. Special Rules for REITs

b. Special Rules For Life Insurance Companies

c. Special Rule Relating To Carrybacks To Years To Which §965 Applies

2. Net Operating Losses Arising in Tax Years Beginning After December 31, 2020

a. Farming Losses

b. Losses of Non-Life Insurance Companies

3. Net Operating Losses Arising in Tax Years Beginning Before January 1, 2018

a. Real Estate Investment Trusts

(1) Net Operating Losses for REIT Years

(2) Net Operating Losses for Non-REIT Years

b. Specified Liability Losses

(1) 10-Year Carryback Period

(a) 10-Year Carryback Period Replaces Two-Year Carryback Period

(b) Coordination With Other Net Operating Losses

(2) Product Liability Losses

(a) Deductible Under §162 or §165

(b) Product Liability

(i) Definition of Product Liability

(ii) Direct Relationship to Product Liability Required

(iii) Services

(iv) Insurance Expenses and Recoveries

(3) Deferred Statutory Liability Losses

(a) Requirements

(b) Elements of a Specified Liability Loss

(i) Amount Allowable as a Deduction

(A) In General

(B) Costs Allocated to Inventory

(ii) Satisfaction of a Liability Under a Federal or State Law

(iii) Five Types of Qualifying Liabilities

(A) Reclamation of Land

(I) Covered Expenses

(II) Effect of Election Under §468

(B) Decommissioning of Nuclear Power Plant

(I) Options for Deducting Nuclear Decommissioning Costs

(II) Covered Expenses

(III) Alternative Carryback Period

(D) Remediation of Environmental Contamination

(E) Payments Under Workers Compensation Acts

(iv) Three-Year Requirement

(A) Case Law

(B) Specific Contexts: Reclamation and Environmental Contamination

(D) Depreciation Deductions

(v) Accrual Method of Accounting

(4) Election to Waive 10-Year Carryback Period

c. Corporate Equity Reduction Interest Losses

(1) Carryback Restriction

(2) Criteria for Application of Exception

(a) Corporate Equity Reduction Transactions

(i) Major Stock Acquisitions

(ii) Excess Distributions

(b) Applicable Corporations

(d) Loss Limitation Year

(3) Examples

d. Farming Losses

(1) Five-Year Carryback Period

(2) Election to Waive Five-Year Carryback Period

e. Losses From Casualty, Theft, and Federally Declared Disasters

(1) Eligible Losses

(a) Casualty and Theft Losses of Individuals

(b) Federally Declared Disasters

(2) Ineligible Loss

(3) Waiver of Three-Year Carryback Period

f. Expired Exceptions to General Carryback or Carryover Rules

C. Election to Waive Carryback Period

1. The Limited Scope of Waiver for Net Operating Losses Arising in Tax Years Beginning After December 31, 2017

2. Rules for Waiving Carryback Under §172(b)(3)

a. In General

(1) Effect of §172(b)(3) Waiver Generally

(2) Effect of §172(b)(3) Waiver on Extended Carryback Periods for Net Operating Losses Arising in Tax Years Beginning Before January 1, 2021

b. Requirements for Election

(1) Statement Requirement

(a) Use the Term “Elect” or “Election”

(b) Refer to §172(b)(3) and Avoid Erroneous Citations

(d) Taxpayer Signature Not Required

(2) Timing Requirement

(3) Substantial Compliance

c. Election by Corporations

d. Election Irrevocable

(1) Irrevocable Election as a Calculated Risk

(2) Bankruptcy

e. Consolidated Returns

D. Law Applicable to Determine Carryback and Carryover Periods

V. Calculating Net Operating Loss Carrybacks and Carryovers

A. Introduction

B. Order of Carryback and Carryover

C. Amount of Carrybacks and Carryovers

1. First Carryback or Carryover Year

2. Additional Carryback or Carryover Years

a. Formula for Determining Amount of Carryback or Carryover

(1) Tax Years Beginning Before January 1, 2018

(2) Tax Years Beginning After December 31, 2017 and before January 1, 2021

(3) Tax Years Beginning After December 31, 2020

b. Modified Taxable Income

(1) Modified Taxable Income Defined

(2) Calculation of Modified Taxable Income

(a) Step 1: Modifications Used to Determine Modified Adjusted Gross Income

(i) Net Operating Loss Deduction

(ii) Limitation on Capital Losses

(iii) Disallowance of Exclusion for Certain Capital Gains Under §1202

(iv) Disallowance of Domestic Production Activities Deduction Under §199

(v) Disallowance of Qualified Business Income Deduction Under §199A

(vi) Disallowance of Deduction for Foreign-Derived Intangible Income (FDII) Under §250

(vii) Recomputation of Certain Income and Deductions Based on or Limited by Adjusted Gross Income

(b) Step 2: Modification and Recomputation Used to Determine Modified Taxable Income

(i) Deduction for Personal Exemptions

(ii) Recomputation of Deductions Subject to Percentage Limitations

(3) Application of Modifications in Particular Contexts

(a) Loss Not Carried to Earlier Tax Year

(b) Zero Taxable Income in Earlier Tax Year

(d) Loss Year Closed by Statute of Limitations

(4) Special Rules for Real Estate Investment Trusts

(a) Use of Real Estate Investment Trust Taxable Income

(b) Treatment of Capital Gain Dividends

c. Examples of Net Operating Loss Carrybacks

d. Example of Net Operating Loss Carryover

3. Self-Employment Tax Not Recomputed

D. Law Applicable to Determine Amount of Carrybacks and Carryovers

VI. Deduction Allowed

A. Amount Deductible

1. Net Operating Losses Arising in Tax Years Beginning After December 31, 2020

2. Net Operating Losses Arising in Tax Years Beginning After December 31, 2017 And Before January 1, 2021

3. Net Operating Losses Arising in Tax Years Beginning Before January 1, 2018

B. Substantiation of Net Operating Loss Deduction

C. Recomputation of Tax for Carryback Year for Net Operating Losses Arising in Tax Years Beginning Before January 1, 2021

D. Self Employment Tax

E. Law Applicable to Determine Amount of Net Operating Loss Deduction

VII. Special Rules

A. Married Taxpayers

1. No Change in Marital or Filing Status

a. All Joint Returns Filed in Carryback and Carryforward Years

b. All Separate Returns Filed in Carryback and Carryforward Years

2. Change in Filing Status

a. From Separate to Joint Returns in Carryback and Carryforward Years

b. From Joint to Separate Returns in Carryback and Carryforward Years

(1) Modification: Allocate Joint Net Operating Loss to Spouses

(2) Modification: Joint Return Filed in Intervening Year

c. Recurrent Use of Joint Returns

3. Change in Marital Status

B. Consolidated Return

C. Discharge of Indebtedness

1. Income Inclusion and Exclusion

2. Reduction of Net Operating Losses and Loss Carryovers

3. Estates of Individuals in Chapter 7 or Chapter 11 Bankruptcy Proceedings

a. Bankruptcy Estate as Taxable Entity

b. Net Operating Loss Carryovers

c. Pre- and Post-Bankruptcy Elections by a Debtor to Relinquish Carryback

d. Post-Bankruptcy Net Operating Loss Carrybacks

e. Termination of Bankruptcy Estate

4. Other Bankruptcy Proceedings

D. Averaging of Farm Income

VIII. Tax Returns and Compliance

A. Tax Returns

1. NOL Carrybacks

a. Amended Return

b. Application for Tentative Carryback Adjustment (”Quick Refund”)

c. Special Rule for Corporations Expecting a Net Operating Loss

2. Carryovers

a. Individuals

b. Corporations

3. Required Statement

4. Schedule UTP, Uncertain Tax Position Statement

B. Interest

1. Interest on Overpayments

2. Interest on Underpayments.

C. Assessment Period

IX. Alternative Minimum Tax Treatment

A. Introduction

B. Alternative Tax Net Operating Loss Deduction

1. Limitation on Amount of Deduction

2. Calculation of Net Operating Loss

3. Amount of Carrybacks and Carryovers

C. Carrybacks and Carryovers

1. In General

2. Waiver of Carryback

X. Background of the Deduction

TABLE OF WORKSHEETS

Carla Neeley Freitag
Owner
Tax Research and Writing

Net Operating Losses — Concepts and Computations (Portfolio 539)

Description

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