More on Net Operating Losses (NOL) and IRS Form 1045 Application for Tentative Refund - John R. Dundon II, Enrolled Agent
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More on Net Operating Losses (NOL) and IRS Form 1045 Application for Tentative Refund

More on Net Operating Losses (NOL) and IRS Form 1045 Application for Tentative Refund

The basic intent of the tax laws governing Net Operating Losses (NOL) is to provide tax payment relief and reduce the need to make tax payments in related years when a loss is not incurred in business or trade. Difficulty often arises when applying tax law to the carry back or carry forward of NOLs. It seems from the inception of NOL rules in 1918 as a temporary post-WWI relief measure, the number of years allowable for carryback or carryover purposes depended on Congressional winds, generally in response to economic upheavals.

IRS Form 1045, Application for Tentative Refund, completed to carry back net operating losses at the individual level, is confusing at best and terrifying at its worst. You have to pay attention to changes in the tax law to know whether you can carry the loss back 2, 3, or 5 years.  You also have to know what qualifies as a net operating loss and whether or not you actually have an NOL.  For clarification on a specific question, the fact that you as an individual have more itemized deductions than you do income to take them against does not mean you have an NOL.

Unfortunately, calculating the net operating loss is not as simple as plugging figures into a form.  Several modifications must be made, including (for individual filers):

1.        Personal and dependency exemptions cannot be used.

2.        Net operating losses from a different year cannot be used.

3.        Nonbusiness capital losses, those arising outside your trade or business, can only be used against nonbusiness capital gains.

4.        Nonbusiness deductions, such as charitable donations, deductible medical expenses, mortgage interest, alimony, etc., can only be used against nonbusiness income.

Once it is determined that you indeed have a net operating loss a decision has to be made whether to carry the NOL back to prior years or to carry it forward.  If you elect to waive the carry back period, however, once the election is made it is irrevocable.  Consulting me directly for assistance in making this decision would be wise. The application of an NOL to prior years is a multi-step, complicated calculation which requires the adjustment and re-figuring of man line items, such as taxes owed and the taxable income in the carry-back year as well as the deductions taken in that year.

For those new to the 1045 the first quandary is which year goes in what column.  Instructions for IRS Form 1045 state to begin with the earliest year.  Thus if this is 2010 and you want to carry the NOL back 3 years, you would begin with 2007. The mechanics of carrying an NOL to a prior year become involved.  The tax for the prior year must be refigured by re-computing the adjusted gross income for that year.  Then any items limited by the AGI must be recomputed, such as allowances for passive activities, taxable SSB, IRA deductions, and excludable savings bond interest.  Next, the taxable income is refigured to reflect changes in itemized deductions for medical expenses, casualty losses, and miscellaneous itemized deductions. If AMT applied to the taxpayer it will also come into play.

Estates and trusts, as well as corporations, may also make use of net operating losses.  Corporations wishing to carry back NOLs against prior years file IRS Form 1139, Corporation Application for Tentative Refund.  Be aware that rules for carry backs may differ.