If your deductions for the year are more than your income for the year, you have a potential NOL.
There are rules that limit what you can deduct when figuring an NOL. In general, you cannot deduct the following items.
- Personal exemptions.
- Capital losses in excess of capital gains.
- The section 1202 exclusion of 50% of the gain from the sale or exchange of qualified small business stock.
- Nonbusiness deductions in excess of nonbusiness income.
- Net operating loss deduction.
Schedule A (Form 1045).
Use Schedule A (Form 1045) to figure an NOL. This discussion explains Schedule A and includes an illustrated example.
First, complete lines 1-3 of Schedule A, using amounts from your return. If line 3 is a negative amount, you have a potential NOL.
Next, complete the rest of Schedule A to figure your NOL. Adjust the amount on line 3 for deductions that are allowed when figuring your taxable
income but not allowed when figuring an NOL. The following discussions explain these adjustments.
Adjustment for exemptions (line 4).
You cannot deduct your personal exemption or your exemptions for dependents. An estate or trust cannot deduct its exemption amount. Your adjustment
is the total amount you deducted for exemptions.
Adjustment for nonbusiness deductions (line 12).
The amount of your nonbusiness deductions (line 9) is limited to the total of:
- Your nonbusiness capital gains less your nonbusiness capital losses (not including any section 1202 exclusion shown as a loss on Schedule D,
Form 1040) (line 8), and
- Your nonbusiness income other than capital gains (line 10).
Your adjustment is your nonbusiness deductions that are more than the total of (1) and (2).
Nonbusiness deductions (line 9).
Enter on line 9 deductions that are not connected to your trade or business or your employment. Examples of deductions not related to your trade or
business are:
- Alimony,
- Contributions to an IRA or other self-employed retirement plan,
- Itemized deductions (except for casualty and theft losses and any employee business expenses), and
- The standard deduction (if you do not itemize your deductions).
Do not enter business deductions on line 9. These are deductions that are connected to your trade or business. They include the following.
- State income tax on business profits.
- Moving expenses.
- The deduction of one-half of your self-employment tax or your deduction for self-employed health insurance.
- Rental losses.
- Loss on the sale or exchange of business real estate or depreciable property.
- Your share of a business loss from a partnership or S corporation.
- Ordinary loss on the sale or exchange of stock in a small business corporation or a small business investment company.
- If you itemize your deductions, casualty and theft losses (even if they involve nonbusiness property) and employee business expenses (such
as union dues, uniforms, tools, education expenses, and travel and transportation expenses).
- Loss on the sale of accounts receivable (if you use an accrual method of accounting).
- Interest and litigation expenses on state and federal income taxes related to your business.
- Unrecovered investment in a pension or annuity claimed on a decedent's final return.
- Payment by a federal employee to buy back sick leave used in an earlier year.
Nonbusiness income (line 10).
Enter on line 10 only income that is not related to your trade or business or your employment. For example, enter your annuity income, dividends,
and interest on investments. Also, include your share of nonbusiness income from partnerships and S corporations.
Do not include on line 10 the income you receive from your trade or business or your employment. This includes salaries and wages,
self-employment income, and your share of business income from partnerships and S corporations. Also, do not include rental income or ordinary gain
from the sale or other disposition of business real estate or depreciable business property.
Adjustment for section 1202 exclusion (line 20).
Enter on line 20 any gain you excluded under section 1202 on the sale or exchange of qualified small business stock.
Adjustments for capital losses (lines 24 and 25).
The amount deductible for capital losses is limited based on whether the losses are business capital losses or nonbusiness capital losses.
Nonbusiness capital losses.
You can deduct your nonbusiness capital losses (line 5) only up to the amount of your nonbusiness capital gains (line 6), without regard to any
section 1202 exclusion. If your nonbusiness capital losses are more than your nonbusiness capital gains, you cannot deduct the excess.
Business capital losses.
You can deduct your business capital losses (line 14) only up to the total of:
- Your nonbusiness capital gains that are more than the total of your nonbusiness capital losses and excess nonbusiness deductions (line 13),
and
- Your total business capital gains (line 15), without regard to any section 1202 exclusion.
Line 24.
The adjustment on line 24 is your capital loss deduction (line 22) that is more than your net capital loss, without regard to any section 1202
exclusion (line 21).
Line 25.
The adjustment on line 25 is your nondeductible capital losses (line 18) that are more than the nondeductible net capital loss (line 23) on your
return, without regard to any section 1202 exclusion claimed on Schedule D. (You had a nondeductible net capital loss if your net capital loss was
more than your capital loss deduction.
Adjustment for NOL deduction (line 26).
You cannot deduct any NOL carryovers or carrybacks from other years. Your adjustment is the total amount of your NOL deduction for losses from
other years.
Illustrated Schedule A (Form 1045)
The following example illustrates how to figure an NOL. It includes filled-in pages 1 and 2 of Form 1040 and Schedule A (Form 1045).
Example.
Glenn Johnson is in the retail record business. He is single and has the following income and deductions on his Form 1040 for 2001.
| INCOME |
|
| Wages from part-time job |
$1,225 |
| Interest on savings |
425 |
| Net long-term capital gain on sale of real estate used in business |
2,000 |
| Glenn's total income |
$3,650 |
| DEDUCTIONS |
|
| Net loss from business (gross income of $67,000 minus expenses of $72,000) |
$5,000 |
| Net short-term capital loss
on sale of stock |
1,000 |
| Standard deduction |
4,550 |
| Personal exemption |
2,900 |
| Glenn's total deductions |
$13,450 |
Form 1040, page 1
Form 1040, page 2
Form 1045, page 2
Glenn's deductions exceed his income by $9,800 ($13,450 - $3,650). However, to figure whether he has an NOL, he must adjust certain
deductions. He uses Schedule A (Form 1045) to figure his NOL. See the illustrated Schedule A (Form 1045) included later.
Glenn cannot deduct the following items on Schedule A (Form 1045).
| Nonbusiness net short-term capital loss |
$1,000 |
| Nonbusiness deductions
(standard deduction, $4,550) minus
nonbusiness income (interest, $425) |
4,125 |
| Personal exemption |
2,900 |
| Total adjustments to net loss |
$8,025 |
Therefore, Glenn's NOL for 2001 is figured as follows:
| Glenn's total 2001 income |
$3,650 |
| Less: |
| Glenn's original 2001 total deductions |
$13,450 |
| Less: |
| Glenn's total adjustments to net loss (above) |
- 8,025 |
- 5,425 |
| Glenn's NOL for 2001 |
$1,775 |
When the total adjustments are made, Glenn's net loss is reduced to $1,775 ($9,800 - $8,025).
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