A primer on individual NOLs.

• Author: Kirk, David H.
• Position: Net operating loss

In the aftermath of the 2005 Atlantic hurricane season, new laws were enacted to give relief to individuals affected by Katrina, Rita and Wilma, and to promote economic recovery in the affected regions. Some of the newly enacted provisions relate to casualty losses and retirement plan withdrawals; however, significant relief for individuals has already been available for decades, through the Sec. 172 net operating loss (NOL) deduction. (For coverage of Hurricane Katrina Relief, see the Tax Clinic in the January 2006 issue.)

The year of NOL creation provides some interesting planning opportunities that are unique to NOL years. However, the planning benefits in the year of NOL creation may be offset with planning for use of the NOL and to minimize exposure to the alternative minimum tax (AMT). A multi-year tax projection that represents the effect of an NOL carryback and carryforward will likely be the best tool to maximize an NOL'S benefit.

Creation of the NOL

Put simply, an individual NOL is created when business deductions in excess of business income also exceed net nonbusiness income; see Sec. 172(d)(4). Thus, as a general rule, an individual taxpayer cannot have an NOL unless the return contains business deductions. Ordinarily, taxpayers with losses (i.e., excess business deductions), reported on Schedules C, E or F, have the greatest likelihood of having an NOL.

Casualty losses: A significant exception is casualty losses. Personal casualty losses are business deductions for purposes of calculating an NOL; see Sec. 172(d)(4)(C). Once a taxpayer satisfies the 10% adjusted gross income (AGI) limit (not applicable to Katrina-, Rita-and Wilma-related losses; see Gurene, Tax Clinic, "Hurricane Katrina: Claiming Casualty Losses," TTA, January 2006, p. 19), any deductible casualty loss will be deemed a business deduction. In addition to its special designation as a "business deduction," a taxpayer can elect to deduct a casualty loss in the tax year prior to the loss year. However, this applies only to casualty losses occurring in Presidentially declared disaster areas; see Sec. 165(i)(1). Further, for individuals who created an NOL due to casualty losses, the carryback period is extended from two years to three; see Sec. 172(b)(1)(F). Thus, with the combination of the Sec. 165(i) election and the three-year carryback, taxpayers can effectively use Katrina-, Rita- and Wilma-related losses to offset income from 2000-2004 first and then in 2005 and beyond.

However, the Gulf Opportunity Zone Act of 2005 (GO Zone Act) Section 101 (a) extended the two-year carryback to five years for tax...