Small Business Deductions: Business Losses vs NOLs

TABLE 1: Jim's Income

Income	Amount
Wages from a part-time job	$1,225
Interest on a personal account	425
Net long-term capital gain on the sale of real estate used in his business	2,000
Total 2011 Income	$3,650

TABLE 2: Jim's Deductions

Deductions	Amount
Net loss from his business (Assume: Gross business income of $67,000 MINUS total business expenses of $72,000)	$5,000
Net short-term capital loss on the sale of stock owned personally by Jim	1,000
Standard deduction - Jim is under 65 and does not itemize	5,800
Jim's personal exemption (he has no dependents)	3,700
Total 2011 Deductions	$15,500

Jim's total deductions of $15,500 exceed his income of $3,650 by $11,850 (this is the negative amount that would be indicated on line 41 of Form 1040).

However, the $11,850 negative amount in NOT his NOL. This is just the first clue that a net operating loss may exist.

Schedule A of Form 1045 must be completed to determine if a net operating loss exists, and, if so, its amount.

TABLE 3: Disallowed Items

Description	Amount
Jim's nonbusiness short-term capital loss	$1,000
Jim's nonbusiness deductions in excess of nonbusiness income (his standard deduction of $5,800 MINUS his nonbusiness interest income of $425)	5,375
Jim's personal exemption (also a nonbusiness deduction)	3,700
Total Disallowed Deductions (cannot use in figuring NOL)	$10,075

TABLE 4: Jim's NOL Computation

Description	Amount
Jim's total 2011 income (from  Table 1)	$3,650
Deduct: Total 2011 Deductions (Table 2) of $15,500 REDUCED BY Disallowed deductions of $10,075 (Table 3) EQUALS allowable deductions of $5,425	(5,425)
Jim's 2011 NOL ($3,650 MINUS $5,425)	$1,775

The $5,425 amount that Jim is allowed to deduct from his total income takes  two items into account:

1. His $5,000 net business loss
2. The decrease in disallowed items of $425

Jim has a choice:

• Jim may carry back the $1,775 NOL two years and get a refund, or
• Waive the carryback period, and just carry it forward to reduce his tax liability in a tax year after the NOL year.

REMINDER:

• If line 41 of Form 1040 shows a negative amount this is your first clue that a net operating loss may exist.
• Form 1045, Schedule A (instructions) must be completed to determine if you actually have a net operating loss, and, if so, its amount.