NOLs are so bizarre (Post-2017 Net Operating Loss)

Technical topics regarding tax preparation.
#21
Chay  
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Nilodop wrote:How do you know whether the excess over $10.000 of such taxes is comprised of property taxes or business-attributed state income taxes?

Section 67 presents the closest parallel I can think of. In the instructions for Form 8960, the limitation is treated as reducing each deduction pro-rata. That's how I think it should be done in this case too.

J. Maule wrote:Only in two limited situations, for limited purposes, has the IRS taken the position that certain deductions must be claimed. One involves the computation of self employment income for social security purposes. The other involves the earned income tax credit issue, itself tied by cross-reference to the self-employment question.

My point is that for the IRS to be able to take that position, it must be a plausible interpretation of some statute or other. There are only two possibilities I can conceive of:

  1. The IRC as written requires deductions that a taxpayer is entitled to claim be taken into account.
  2. The position derives from something outside the IRC such as section 208 of the Social Security Act.
The point here is not to argue over whether taxpayers are somehow legally or ethically bound to claim deductions no matter what. Clearly, this is not the case. The point is to examine whether or not the conclusion reached in Rev. Rul. 56-407 should be applied to all other situations where omitting a deduction produces a tax benefit.
 

#22
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Nilodop wrote:In the case that state and local income taxes plus property taxes exceed $10,000, I have only this to go by:. That's exactly what I was getting at. How do you know whether the excess over $10.000 of such taxes is comprised of property taxes or business-attributed state income taxes? We need to know because RR 70-40 concludes thusly (emphasis added):
Accordingly, it is held that expenditures for State individual income taxes on net income from business profits, interest on State and Federal income taxes that are related to income derived from a trade or business carried on by the taxpayer, and litigating expenses in connection with such taxes, are "attributable to a taxpayer's trade or business" for purposes of section 172(d)(4) of the Code and, provided they are otherwise deductible, are allowable deductions in determining the net operating loss deduction.


1. If, as Chay suggested, we claim e.g. $8,000 in state income taxes and $2,000 in property tax (even though we paid $12,000 in property tax) and if we believe James Maule, then all of the state income taxes are "otherwise deductible".

2. If we fall into the "all deductions are mandatory" camp, then I think proportionally reducing the state income tax by 10,000/20,000 = 50% is appropriate.

I know, that's a lot of "if"s. This is a case where I would present both options to a client with risk estimates and let them decide what to do. FWIW, my SWAG* is that option 1 is correct with about 75% likelihood.

*Scientific Wild-Ass Guess
 

#23
Nilodop  
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Section 67 presents the closest parallel I can think of. In the instructions for Form 8960, the limitation is treated as reducing each deduction pro-rata. That's how I think it should be done in this case too.. Mind illustrating it in an example? Does it matter what you do first? Let's keep it easy - state income taxes were 10,000, of which 4,000 is "attributable" to business income, and state property taxes, all personal, were 10,000. What's the effect on NOL calculation?
 

#24
makbo  
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If I may resurrect this, most of the above was TL;DR for me because I don't think the situation I am looking at involves state tax limitations (but I could be wrong).

In this case, NOL = ( AGI - nonbusiness income)

The issue comes down to the Deductible part of Self Employment Tax. All of the Business Income is offset by the SEHI for this taxpayer (which is critical to this outcome), but the 1/2 SE tax adjustment for AGI is not offsetting anything, yet it is not included in Line 1 of the calculation below. So, it becomes an NOL all by itself.

In the case of my client, I'm going to be lazy and use actual instead of rounded numbers, but hopefully still not identifying the client by doing so:

NOL Operating Loss Worksheet
1. (2,426) subtract std/itemized deduction (28,361) from AGI (25,935)
6. 28,361 Nonbusiness deductions
7. 26,090 Nonbusiness income
9. 2,271 Line 6 - 7
25. (155) NOL (Line 1 + 9)

Nonbusiness deductions are:

Schedule A Medical Expense Deduction $ 5,864
Schedule A Taxes Paid 4,151
Schedule A Home Mortgage Interest 17,346
Schedule A Charitable Contributions 1,000

Nonbusiness income is:

Interest Income $ 5,493
Dividend Income 27
Taxable Pensions 20,006
Other Income 564
 

#25
makbo  
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CA also calculates the same NOL amount (which taxpayer will elect to carry forward) and they don't allow a deduction for state income tax, for whatever that proves.
 

#26
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makbo wrote:The issue comes down to the Deductible part of Self Employment Tax. All of the Business Income is offset by the SEHI for this taxpayer (which is critical to this outcome), but the 1/2 SE tax adjustment for AGI is not offsetting anything, yet it is not included in Line 1 of the calculation below. So, it becomes an NOL all by itself.


I think this is the issue. The SE tax deduction is supposed to reduce the profit available to be offset by the SEHI deduction. See the worksheet from page 91 of the 1040 instructions, specifically this part:

IRS wrote:[...]minus any deductions on Schedule 1, lines 27 [Deductible part of self-employment tax] and 28 [Self-employed retirement plans].


So I think your AGI is off by 155 and should be 26,090.

You should have something like:

2,194 on Schedule 1, line 12 (Business income),
155 on Schedule 1, line 27 (Deduction for SE Tax), and
2,039 on Schedule 1, line 29 (SEHI deduction).

Instead, I think you have 2,194 on line 29.
 

#27
makbo  
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MSchmahl wrote:I think this is the issue. The SE tax deduction is supposed to reduce the profit available to be offset by the SEHI deduction.

Yes, you are correct. At first, I thought this was a new 2018 bug in my software, but now I see it is rather a data entry error that I think should have been flagged as a critical diagnostic, but it wasn't flagged at all.

Way back in my first post, I mentioned this taxpayer was recently widowed. 2018 is the first year with filing status single. When it is the taxpayer who is deceased, UltraTax seems to do a good job for the most part of automatically moving the spouse data entry over to the (single) taxpayer input for the following year, but in this case the Schedule C was still attributed to "Spouse", even though there was no spouse on the return and filing status was "Single". The SE tax itself was nonetheless calculated correctly, with the taxpayer's SSN, but the SEHI was not (it was calculated, but without the adjustment for 1/2 SE tax). Schedule C itself had blanks for the name/SSN of the proprietor.

So, I give myself partial credit for thinking something was odd about my software's result, even though I was too lazy to figure it out on my own. Then I give myself a tiny bit more credit for taking the time to bring up the topic here, which eventually let to the correct result, fortunately before the return is filed.

Thank you for taking the time to help me figure it out (and everyone else who contributed to a lively discussion as well).
 

#28
Doug M  
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I find most software companies don't have enough information to correctly identify the various components of an NOL computation. Business income and deductions, business capital gains, nonbusiness income and deductions.

What did you get when you prepared Schedule A, form 1045?
 

#29
makbo  
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Doug M wrote:What did you get when you prepared Schedule A, form 1045?

In my post #24, the section titled "NOL Operating Loss Worksheet" is the same thing as Schedule A, Form 1045 would be.

I think UT would probably do a pretty good job of figuring the NOL. Ironically, I started this thread by saying that "good software helps with NOLs". My problem was not caused by NOL calculations per se, but rather an inconsistent treatment of data entry made for S(pouse) on a return with single filing status (no spouse). For most purposes it was ignored and treated as taxpayer, but for the SEHI, it was incorrectly treated as belonging to the non-existent spouse, yet still reported on the return in some places but not others.
 

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