Chapter 8 Losses and Bad Debts Federal Taxation

Chapter 8 Losses and Bad Debts Federal Taxation 2017 Individuals

Losses and Bad Debts - Topics • Transactions that may result in losses • Classifying losses on the taxpayer’s tax return • Passive losses • Casualty and theft losses • Bad debts • Net operating losses • Tax planning considerations 2

Transactions that May Result in Losses Sale or Exchange of Property • Amount realized includes liability transferred to buyer • Selling costs – Inventory: Deducted in year incurred – Non-Inventory: Reduction of amt realized 3

Transactions that May Result in Losses Seized and Abandoned Property • Expropriated, seized, confiscated prop – If not a casualty or theft • Treated as sale or exchange • Abandoned property – Ordinary loss if bus. or invest. property – Nondeductible if personal property • Demolition of property – Add cost of demolition to basis of land 4

Transactions that May Result in Losses Worthless Securities • Securities must be completely worthless • Capital loss on last day of tax year 5

Classifying the Losses on the Taxpayer’s Tax Return • Ordinary vs. capital loss • § 1244 stock • Disallowance possibilities 6

Ordinary vs. Capital Loss • Dependent on type of property involved and type of transaction involved • Capital gain • – On sale or exchange – Of capital asset § 1231 property – Includes real or depreciable property used in a trade or business and held for more than one year – Net § 1231 loss is an ordinary loss – Net § 1231 gain is a LTCG 7

§ 1244 Losses • Capital Losses have TIMING limits • If Capital losses are > than Capital Gains – Can deduct up to Capital Gains – Plus 3000 – Carry forward the rest But, if stock is § 1244 Can reclassify PART of loss as ordinary 100, 000 if MFJ 50, 000 if single/H of H This is good because: 1) Not subject to timing limits 2) Offsetting Ordinary Income at higher rates 3) Not Offsetting Long term Capital Gain and 15% rate 8

§ 1244 Stock • Losses on § 1244 stock treated as ordinary rather than capital loss – $50 K limitation or $100 K if filing MFJ • Qualification as § 1244 stock – ≤ 50% of gross receipts from passive sources during prior 5 tax years, AND – Contributions to capital and paid-in surplus ≤ $1 M at time of issue 9

Disallowance Possibilities • Transfers of property to controlled corporation in exchange for stock • Property sold to certain related parties • Wash sales • Losses limited because losses exceed amount for which taxpayer is at risk 10

8 -39 Section 1244 Losses. During the current year, Karen sells her entire interest in Central Corporation common stock for $22, 000. She is the sole shareholder, and originally organized the corporation several years ago by contributing $89, 000 in exchange for her stock, which qualifies as Sec. 1244 stock. Since its incorporation, Central has been involved in the manufacture of items that protect personal computers from static electricity. Unfortunately, this market is extremely competitive, and Central Corporation incurs substantial losses throughout its existence. a. Assuming Karen is single, what are the amount and the character of the loss recognized on the sale of the Central Corporation stock? Amount realized Minus: Basis Loss recognized $ 22, 000 ( 89, 000) $(67, 000) (50, 000) § 1244 Ordinary LOSS (17, 000) Capital Loss b. Assuming Karen is married and files a joint return Amount realized Minus: Basis Loss recognized $ 22, 000 ( 89, 000) $(67, 000) ALL § 1244 Ordinary LOSS Because limit for married couple is 100, 000 of Ordinary 11

8 -39 Section 1244 Losses. During the current year, Karen sells her entire interest in Central Corporation common stock for $22, 000. She is the sole shareholder, and originally organized the corporation several years ago by contributing $89, 000 in exchange for her stock, which qualifies as Sec. 1244 stock. Since its incorporation, Central has been involved in the manufacture of items that protect personal computers from static electricity. Unfortunately, this market is extremely competitive, and Central Corporation incurs substantial losses throughout its existence. c. How would your answer to Part a change if Karen had originally purchased the stock from another shareholder rather than organizing the corporation? Amount realized Minus: Basis Loss recognized $ 22, 000 ( 89, 000) $(67, 000) ALL CAPITAL LOSS § 1244 Doesn’t Apply To qualify the loss as ordinary under Sec. 1244, the stock must have been originally issued to the individual or to a partnership in which an individual is a partner. Therefore, under this revised fact pattern the sale of the stock would result in a $67, 000 long‑term capital loss. 12

8 -39 Section 1244 Losses. During the current year, Karen sells her entire interest in Central Corporation common stock for $22, 000. She is the sole shareholder, and originally organized the corporation several years ago by contributing $89, 000 in exchange for her stock, which qualifies as Sec. 1244 stock. Since its incorporation, Central has been involved in the manufacture of items that protect personal computers from static electricity. Unfortunately, this market is extremely competitive, and Central Corporation incurs substantial losses throughout its existence. d. How might Karen have structured the transaction in Part a to receive a greater tax advantage? REMEMBER: Amount realized Minus: Basis Loss recognized $ 22, 000 ( 89, 000) $(67, 000) (50, 000) § 1244 Ordinary LOSS (17, 000) Capital Loss d. By selling a portion of the stock in one year and the remaining stock in another year the taxpayer could convert all $67, 000 to an ordinary loss. The $50, 000 maximum is per taxable year. This would also avoid the annual $3, 000 limit on the deductibility of capital losses. Year 2 Year 1 ◦ Amount realized $ 5, 600 $ 16, 400 ◦ Minus: Basis ( 22, 655) ( 66, 345) ALL ORDINARY LOSS!! Loss recognized $(49, 945) $(17, 055) 13

8 -41 a. Sale of 1/3 Stewart 85, 000 AR -100, 000 AB (1/3 300, 000) -15, 000 Ordinary 1244 c. Sale of Microsoft 25, 000 AR -45, 000 AB -20, 000 LTCL e. Sale of Wavetable 20, 000 AR -26, 000 AB - 6, 000 STCL f. Loan to friend b. Sale of IBM 15, 000 AR -10, 000 AB 5, 000 LTCG ORDINARY a. -15, 000 (1244) h. 114, 000 Salary d. Sale of Tidal Radio 32, 000 AR -12, 000 AB 20, 000 STCG SHORT TERM CAPITAL d. 20, 000 e. -6, 000 f. -14, 000 STCL g. Loss on BTR 100, 000 AR - 8, 000 Expected Return - 92, 000 LTCL EXPECTED LONG TERM CAPITAL b. 5, 000 c. -20, 000 g. -92, 000

8 -41 Ordinary a. -15, 000 (1244) h. 114, 000 Salary Short Term Capital d. 20, 000 e. -6, 000 f. -14, 000 Long Term Capital b. 5, 000 c. -20, 000 g. -92, 000 AGI Calculation 114, 000 Salary 20, 000 STCG Tidal Radio 5, 000 LTCG 139, 000 GI -15, 000 1244 (Ordinary Loss) -6, 000 STCL Wavetable Enough STCG to allow all STCL -14, 000 STCL Loan to friend Up to 5000 LTCG plus 3000 gimme - 8, 000 LTCL 96, 000 AGI Carryover? 20, 000+ 92000 - 8000 deducted = 104, 000 LTCL 15

Passive Losses • • • Computation of passive losses & credits Carryovers Definition of a passive activity Taxpayers subject to passive loss rules Real estate business Other rental real estate activities 16

Computation of Passive Losses and Credits • Income classified into three categories – Active income • E. g. , wages, salaries, active business income – Portfolio income (investment income) • E. g. , interest, dividends, royalties – Passive income • Net income/loss calculated separately for each activity • Passive losses can only offset passive income 17

Carryovers • Suspended losses – Disallowed passive losses that are carried forward indefinitely • Taxable disposition of interest in passive activity – Suspended losses from activity used to reduce gain on disposition after losses used to offset current passive income 18

Definition of a Passive Activity (1 of 2) • Any rental activity • Any trade, business, or investment activity in which taxpayer does not materially participate • Most often interests in – LLCs – S Corporations – Partnerships – Where member/shareholder/partner does not materially participate 19

Definition of a Passive Activity (2 of 2) • Material participation tests – Only need to meet one test • Participate > 500 hrs in activity • Participation constitutes substantially all participation in activity by all individuals • Participate > 100 hrs in activity and participation more than all other individuals • Sum of participation in all passive-type activities > 500 hrs • Material participation in 5 of last 10 years • And others – regulations are 100 pages long 20

Taxpayers Subject to Passive Loss Rules • Applies to individuals, estates, trusts, closely-held C Corporations, PSCs, and certain publicly traded partnerships • Applies to owners of partnerships and S Corporations • Passive loss limits apply in their entirety to a Personal Service Corporation 21

Real Estate Business • Passive activity rules do not apply to real estate professionals who materially participate in real estate trade or business activities if – > 50% of personal services performed in real property trades or businesses AND – Taxpayer performs > 750 hrs in real property trades or businesses 22

Other Rental Real Estate Activities • Taxpayers actively participating in rental real estate activities with AGIs not in excess of $150 K – May deduct – 1) Up to Passive Income from that and other passive Activities (as normal for ALL Passive losses) – 2) $25 K of such rental real estate losses against portfolio and active income – • • Lose 25000 as AGI > 100, 000 by. 5 of each dollar of AGI > 100, 000 Totally lose 25, 000 if AGI is over 150, 000 23

8 -42 Passive Losses. In the current year Alice reports $150, 000 of salary income, $20, 000 of income from activity X, and $35, 000 and $15, 000 losses from activities Y and Z, respectively. All three activities are passive with respect to Alice and are purchased during the current year. What is the amount of loss that may be deducted with respect to each of these activities? Also compute the amount of loss that must be carried over for each activity. Passive Income (Into Gross Income) X 20, 000 Passive Losses Y 35, 000 Z 15, 000 Allowed Deduction 35/50*20, 000 = 14, 000 15/50*20, 000 = 6, 000 Carryforward 21, 000 9, 000 RULES: Can deduct losses only up to Passive Income Carry forward the balance Must prorate between loss activities if there is not enough income WHY DO WE CARE WHICH LOSS IS DEDUCTED OR CARRIED FORWARD (Y OR Z)? 1) Because Character might be different – Y might be Capital, Z Ordinary 2) Because when we sell an activity we get 100% of that loss at time of sale 24

8 -43 Passive Losses. In the current year Clay reports income and losses from the following activities: Passive Activity X $ 28, 000 Passive Activity Y (10, 000) Passive Activity Z (20, 000) Passive Activity Z (40, 000) loss carryover Passive Activity Z 30, 000 gain on sale of Z Salary 100, 000 a. What is the amount of loss that Clay may deduct and what is the amount that must be carried over in the current year? 1) Separate Continuing activities from sold activities 2) Deduct loss from CONTINUING ACTIVITIES up to gain of remaining activities. Income from Passive not sold X 28, 000 into GI Losses from Passive not sold Y - 10, 000 within 28, 000 so deductible 3) Deal with SOLD PASSIVE ACTIVITY Include gain or income in Gross Income Deduct all current and carried over losses even if they exceed passive income SO: 30, 000 gain on sale in Gross Income - 20, 000 current operating loss Deductible -40, 000 loss carryover deductible 25

8 -43 continued – NOW DETERMINE AGI 1) Separate remaining activities from sold activities 2) Deduct loss from remaining activities up to gain of remaining activities. Income from Passive not sold X 28, 000 into GI Losses from Passive not sold Y - 10, 000 within 28, 000 so deductible 3) Deal with Sold Passive Activity Include gain or income in Gross Income Deduct all current and carried over losses even if they exceed passive income SO: 30, 000 gain on sale Gross Income - 20, 000 current operating loss Deductible -40, 000 loss carryover Deductible COMPUTE AGI 100, 000 Salary 28, 000 Passive Activity X 30, 000 gain on sale of Z 158, 000 GI -10, 000 Y Loss -20, 000 Z current loss -40, 000 Z carryover loss 88, 000 AGI 26

8 -44 Passive Losses: Rental Real Estate. During the current year, Irene, a married individual who files a joint return, reports the following items of income and loss: Salary $130, 000 Activity X (passive) 10, 000 Activity Y (rental real estate, nontrade or business ) (30, 000) Activity Z (rental real estate, nontrade or business ) (20, 000) Irene actively participates in activities Y and Z and owns 100% of both Y and Z. Maximum rental real estate loss Reduced by phase out: ($130, 000 ‑ $100, 000) x 0. 50 Deductible amount (not to exceed actual loss of $50, 000) $25, 000 (15, 000) 10, 000 AGI Irene’s AGI for the year is computed as follows: a. $130, 000 Salary Income 10, 000 Activity X a. 140, 000 Gross Income -10, 000 Deductible Rental Real Estate loss (6, 000 for Y and 4, 000 for X) -10, 000 Deductible up to Activity X (6, 000 for Y and 4, 000 for X) $120, 000 AGI 27

8 -44 Activity Y (rental real estate, nontrade or business ) Activity Z (rental real estate, nontrade or business ) (30, 000) (20, 000) Passive Loss Deductions in determining AGI 10, 000 Rental Real Estate Allowance not phased out 10, 000 Offset allowed for Activity X Passive Income 20, 000 Total Passive Losses allowed b. What is the amount of suspended losses (if any) that may be carried over with respect to each activity? 20000 deduction allocated between Y and Z Passive Income (Into Gross Income) X 20, 000 Passive Losses Y 30, 000 Z 20, 000 Allowed Deduction 30/50*20, 000 = 12, 000 20/50*20, 000 = 8, 000 Carryforward 18, 000 12, 000 28

8 -45 Passive Losses. In 2015, Mark purchased two separate activities. Activity A B Status Passive 2015 Income(Loss) ($24, 000) ( 8, 000) Passive Status Active 2016 20, 000 Income(Loss) $10, 000 2015: losses were suspended losses for that year. 2016: salary income of $120, 000, interest and dividend income of $20, 000. Compute the amount (if any) of losses attributable to activities A and B that are deductible in 2015 and any suspended losses carried to 2017. ACTIVITY B: Passive Loss from 2015 deductible against 2016 Passive income In 2016 – 8, 000 loss deductible ACTIVITY A: Passive Loss from 2015 deductible against 2016 Active income and B’s leftover Passive Income 24, 000 carryforward from 2015 - only 22, 000 deductible in 2016 -10, 000 deductible because of A income -12, 000 deductible because of unoffset B Income (20, 000 -8, 000) 2, 000 loss carried forward to 2017 29

8 -45 ACTIVITY B: Passive Loss from 2015 deductible against 2016 Passive income In 2016 – 8, 000 loss deductible ACTIVITY A: Passive Loss from 2015 deductible against 2016 Active income and B’s leftover Passive Income 24, 000 carryforward from 2015 - only 22, 000 deductible in 2016 -10, 000 deductible because of A income -12, 000 deductible because of unoffset B Income (20, 000 -8, 000) 2, 000 loss carried forward to 2017 AGI for the 2016 is computed as follows: a. $120, 000 Salary Income 10, 000 Activity A 20, 000 Activity B 140, 000 Gross Income - 8, 000 Deductible Activity B -22, 000 Deductible Activity A $110, 000 AGI 30

8 -46 � • • • Can deduct or use credits up to Income (or rental allowance) ◦ Passive Losses ◦ Credits (converted to deduction equivalency) Juan, 28% tax bracket & single, AGI of $ 124, 000 before passive activity losses. He also actively participates and owns 100% of rental real estate activity A Activity A generates $ 6, 000 loss $ 3, 000 tax credits. TOTAL ALLOWABLE 0 passive income 13, 000 Rental Allowance 13, 000 Deductions & Equivalency -6000 Deduction (allowed first) 7000 X 28% = 1960 credits Carryforward 3000 Credits -1960 allowed 1040 carried forward RENTAL ALLOWANCE 124, 000 AGI -100, 000 Floor 24, 000 /2 = 25, 000 rental allowance -12, 000 lost (phased-out) 13, 000 Allowed 31

8 -47 1) Compute AGI (to determine rental loss allowance) 2) Compute Taxable Income 3) Compute Amount taxed at CG RATE 4) Determine Carryover Salary Interest Income LTCG GI STCL AGI for passive Passive Rental AGI Itemized Exemption Taxable Income 166, 000 14, 000* 22, 000 202, 000 - 17, 000 185, 000 AGI > 150, 000 all passive rental loss allowance is lost -0 185, 000 - 39, 800 SIDS MIDS - 4, 050 Invest Interest Exp 14, 000* 2, 500 Tax Return Prep 141, 150 Resident Interest 12, 000 Unreim Employ 22, 000 LTCG -17, 000 STCL 5, 000 @ 15% CG Rate Charitable Property Taxes MIDS TOTAL ID Carry forward 20, 000 Passive Rental Loss 8, 000 5, 000 800 39, 800 Less 2% AGI - 3, 700 800 *Carryforward investment interest exp 32 21, 000 -14, 000 = 7, 000

Casualty and Theft Losses (1 of 2) • Casualty defined • Theft defined • Deductible amount of casualty loss • Limitations on personal-use property • Netting casualty gains and losses on personal-use property 33

Casualty and Theft Losses (2 of 2) • Casualty gains and losses attributable to business and investment property • Timing of casualty loss deduction 34

Casualty Defined • A casualty loss results from an identifiable event that was sudden, unexpected, or unusual • Qualifying casualties include fire, flood, hurricane, tornado, and hail 35

Theft Defined • Generally, criminal intent and violation of state law required to meet definition of theft • Includes larceny, embezzlement, robbery, blackmail, extortion, and ransom 36

Limitations on Personal-Use Property • Two limitations (reductions) – Losses sustained in each separate casualty reduced by $100, AND – Sum of all net casualty losses reduced by 10% of taxpayer’s AGI 37

Netting Casualty Gains and Losses on Personal-Use Property • Losses reduced by insurance reimbursement • Casualty losses must be netted against casualty gains prior to applying 10% of AGI limitation – Net casualty subject to 10% limitation 38

Casualty Gains & Losses Attributable to Business & Investment Property • Net casualty loss on business property or investment property used to generate rents or royalties is a for AGI deduction • Losses on other investment property are miscellaneous itemized deductions NOT subject to 2% of AGI floor • If property held <1 yr, treat as ordinary 39

Timing of Casualty Loss Deduction • Generally deduct losses in year in which taxpayer sustains loss • Theft loss deductible when discovered • If insurance reimbursement expected, loss deductible in year reimbursement received • National disaster losses may be deducted in year prior to year sustained 40

8 -49 Theft Losses. On December 17 of the current year, Kelly’s business office safe is burglarized. The theft is discovered a few days after the burglary. $3, 000 cash from the cash registers is stolen. A diamond necklace and a ring that Kelly frequently wore also stolen. The necklace cost Kelly $2, 300 many years ago and is insured for its $6, 000 FMV. Kelly purchased the ring for $3, 000 just two weeks before the burglary. Unfortunately, the ring and the cash are not insured. Kelly’s AGI for the year, not including the items noted above, is $70, 000. a. What is Kelly’s deductible theft loss in the current year? • a. The cash is a 3000 business loss and dfor. No limits on amount. • Necklace and ring are personal casualty. Necklace decline in value is 6000, AB 2300 Ring decline in value = FMV = AB = 3000 – 100 = AB must be used -6000 ins = 3700 gain -2900 loss LTCG STCL 800 net gain No 10% reduction if there is net gain (Note was still 100 reduction per event for loss) 41

8 -49 Theft Losses. On December 17 of the current year, Kelly’s business office safe is burglarized. The theft is discovered a few days after the burglary. $3, 000 cash from the cash registers is stolen. A diamond necklace and a ring that Kelly frequently wore also stolen. The necklace cost Kelly $2, 300 many years ago and is insured for its $6, 000 FMV. Kelly purchased the ring for $3, 000 just two weeks before the burglary. Unfortunately, the ring and the cash are not insured. Kelly’s AGI for the year, not including the items noted above, is $70, 000. • b. What is Kelly’s deductible theft loss in the current year if theft is not discovered until January of the following year? • b. $0 in current year. Theft losses are deductible in the year of discovery. – So, she would have same result as a. but next year 42

8 -50 • • • Jerry sprayed all of the landscaping around his house with a pesticide in June 2016. Shortly thereafter, all of the trees and shrubs unaccountably died. The FMV and the adjusted basis of the plants were $ 15, 000. Later that year, the pesticide manufacturer announced a recall of the particular batch of pesticide that Jerry used. It also announced a program whereby consumers would be repaid for any damage caused by the improper mixture. Jerry is single and reports $ 38, 000 AGI in 2016 and $ 42, 000 in 2017. a. 2016 - No loss to be reported with reasonable expectation of recovery b. If Jerry claimed no loss in 2016 return then 2017 would claim loss Amount of Loss Less: 100 floor Less: 10% of AGI Deductible Loss 13, 500 (15, 000 loss -1500 recovered) - 100 13, 400 - 4, 200 9, 200 c. If Jerry claimed loss in 2016 return then 2017 would have income from tax benefit. The amount would depend on whethere were other ID in 2016 9, 200 ID - 6, 300 SD 2, 900 Minimum Tax Benefit and Income in 2015 43

Bad Debts • Bona fide debtor-creditor relationship • Taxpayer’s basis in the debt • Debt must be worthless • Nonbusiness bad debts • Business bad debts • Deposits in insolvent financial institutions 44

Bona Fide Debtor-Creditor Relationship Related Parties Can’t deduct bad debt unless you have proven it is a real debt. IRS applies “Facts and circumstances test” – Existence of written obligation to repay – Establishment of repayment schedule – Reasonableness of interest rate – Likelihood that unrelated party would have made loan – Genuine attempts to collect 45

Taxpayer’s Basis in the Debt Creditor must have basis in debt Generally, basis is amount loaned – May be income recognized for performing services to debtor 46

Debt Must Be Worthless • Must prove worthlessness to deduct bad debt • Legal action not required 47

Nonbusiness Bad Debts • Definition – Any debt other than • A debt created or acquired in connection to, or results from a trade or business • Tax treatment – Short-term capital loss in year debt becomes totally worthless (regardless of how old debt is) • No loss for partial worthlessness 48

Business Bad Debts • Provides ordinary loss deduction • Generally must use specific write-off method • Recovery of bad debts – Income in year of recovery to extent benefit received from loss 49

Deposits in Insolvent Financial Institutions • Difference between basis in deposit and expected proceeds • Two choices – Treat as personal casualty loss • No limitation on maximum loss claimed – Treat as loss from for-profit activity • Ordinary loss, but subject to $20 K loss limit 50

Net Operating Loss Rules Compute the net operating loss for individuals NOL is Dfor when used LIMITS ON USAGE: Carryback 2 years or carryover 20 years CARRY BACK Recompute taxable income in the carryback year File amended return and claim refund CARRYFORWARD Just deduct if carryforward RECOMPUTE NOL carryfoward remaining after using NOL in a given year 51

Carryback And Carryover Periods Carryback 2 years EXAMPLE: Had NOL in 2016 – Use in oldest year first 2014 - not 2015 – After carryback, NOLs carried forward 20 yrs in chronological order 2017, 2018, etc. – May elect to forgo carryback period Use first in 2017 (not 2014 or 2015) – Losses from multiple years - Use up earliest loss first FIFO 52

Computing the Net Operating Loss for Individuals NOL CALCULATION Taxable Income + NOL Other years + Net NB Cap Losses (losses > gains) There will be only one: EITHER Net NB Capital Loss OR Net NB Capital Gain + Exemptions + NB Exp > NB Income + Net NB Cap Gains (gains > losses) + Business Capital Loss (complicated calculation) 53

8 -56 TAXABLE INCOME Revenues Mark’s Salary Savings Int Gross Income - Payroll - Supplies - Rent - Advertising - Depreciation AGI -SD - 3 Exemptions Taxable income 65, 000 18, 000 1, 200 84, 200 - 49, 000 - 17, 000 - 16, 400 - 4, 600 - 8, 100 - 10, 900 - 12, 600 - 12, 150 - 35, 650 SIDS Mtg. Interest State & Local 7, 100 3, 400 10, 500 USE Standard Deduction 12, 600 NOL CALCULATION Taxable Income -35, 650 + NOL from other Years 0 + NB Capital Loss > NB Capital Gains 0 > 0 0 + Exemptions Allowed + NB Expenses > NB Income + Net NB Capital Gains 12, 600 (SD or ID here) > 1, 200 12, 150 11, 400 b. Michelle and Mark’s NOL for the year -12, 100 54

8 -57 Same facts as in Problem I: 856, except add $ 4, 500 deductible personal casualty loss ( after limitations). TAXABLE INCOME Revenues 65, 000 Mark’s Salary 18, 000 Savings Int 1, 200 Gross Income 84, 200 - Payroll - 49, 000 - Supplies - 17, 000 - Rent - 16, 400 - Advertising- 4, 600 - Depreciation - 8, 100 AGI - 10, 900 -ID - 15, 000 - 3 Exemptions - 12, 150 Taxable income - 38, 050 SIDS Mtg. Interest State & Local Casualty 7, 100 3, 400 4, 500 15, 000 IGNORE Standard Deduction 12, 600 NOL CALCULATION Taxable Income -38, 050 + NOL from other Years 0 + NB Capital Loss > NB Capital Gains 0 > 0 0 + Exemptions Allowed + NB Expenses > NB Income + (Never Casualty) Net NB Capital Gains 10, 500 (ID here) > 1, 200 b. Michelle and Mark’s NOL for the year 12, 150 9, 300 -16, 600 55

8 -58 Same facts as in Problem I: 8 - 56, except $12, 100 mtg int & $ 4, 500 deductible personal casualty loss (after limitations). TAXABLE INCOME Revenues Mark’s Salary Savings Int Gross Income - Payroll - Supplies - Rent - Advertising - Depreciation AGI -ID - 3 Exemptions Taxable income 65, 000 18, 000 1, 200 84, 200 - 49, 000 - 17, 000 - 16, 400 - 4, 600 - 8, 100 - 10, 900 - 20, 000 - 12, 150 - 43, 050 SIDS Mtg. Interest State & Local Casualty 12, 100 3, 400 4, 500 20, 000 IGNORE Standard Deduction 12, 600 NOL CALCULATION Taxable Income -43, 050 + NOL from other Years 0 + NB Capital Loss > NB Capital Gains 0 0 > 0 + Exemptions Allowed 12, 150 + NB Expenses > NB Income + (Never Casualty) Net NB Capital Gains 14, 300 20, 000 ID -4, 500 CAS > 1, 200 b. Michelle and Mark’s NOL for the year -16, 60056

8 -59 TAXABLE INCOME Revenues -CGS LTCG Salary Gross Income - Advertising - Off supplies - Rent - Labor - STCL AGI - SD - Exemption Taxable income 52, 000 -41, 000 4, 200 13, 500 28, 700 - 3, 300 - 1, 700 - 13, 800 - 28, 000 - 3, 800 - 21, 900 - 6, 300 - 4, 050 -32, 250 SIDS 5, 200 Given USE Standard Deduction 6, 300 NOL CALCULATION Taxable Income -32, 250 + NOL from other Years 0 + NB Capital Loss > NB Capital Gains 3, 800 NBCL > 4, 200 NBCG 0 + Exemptions Allowed + NB Expenses > NB Income + Net NB Capital Gains 6, 300 SD > 0 NB Income + 400 Net NB CG b. Karen’s NOL for the year 4, 050 5, 900 57 -22, 300

Recomputation of Taxable Income in the Carryover Year • NOL is a for AGI deduction because it is attributable to taxpayer’s trade or business • NOL carried to other years determined in same manner as original NOL computation 58

Tax Planning Considerations (1 of 2) • Taxpayers should document their determination that a particular debt is worthless • Documentation of fair market value is important to support a casualty loss 59

Tax Planning Considerations (2 of 2) • Taxpayer should consider forgoing NOL carryback to only carry forward if higher marginal rate is expected in future or carryback would jeopardize tax credits 60