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Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22748
Experience:  Taxes, Immigration, Labor Relations
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Hello, I have a Carry Loss Forward question on a bad business

Resolved Question:

Hello, I have a Carry Loss Forward question on a bad business debt.
Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.

Lev : Hi and welcome to Just Answer!
Lev : Please post your question.
Customer:

Here's my loss carry forward question. So back in 2011, my parents, through their company, settled out of court several interest generating notes. They had lent money to this guy over the course of a few years and then he went bankrupt. Through the settlement they received back some properties that totaled about 25cents/dollar. So they incurred a huge loss including lawyers fee's, etc. Anyways, at the end of this year and next year their company stands to make a profit. Is it possible to carry forward the loss from 2011 to this year and the following years so that they can pay little or no income tax. Furthermore, could you apply loss to state income tax in a state like Arizona.

Customer:

Their company is an LLC. They did not file tax return for 2011 or 2012 until this year.

Customer:

They were given an extension for 2012 however

Lev : Can you verify what type of loss it was?
Customer:

How do you mean?

Lev : Is that a single member LLC .
Lev : ?
Customer:

yes

Customer:

well in 2011, when the settlement was made. I was the sole managing member of the company

Customer:

It was loan through my parents company, secured by real estate and personal guarantee. The money was to be used to update apartment buildings for elderly people, veterans, etc.

Customer:

I have the notes and bankruptcy documents

Customer:

including the settlement

Lev :

You mentioned "bad business debt" .. Now you are telling that is a loss based on "interest generating notes" - which is generally an investment loss - not business loss.
that is why we need clarification. these are two different types of loss and are treated differently.

Customer:

Oh okay.

Lev :

The first step - we need to verify if that is a business debt.

Customer:

what would indicate that it was a business debt?

Lev :

How your parents acquired these notes? What was their business?

Customer:

My parents lent money to this man. He secured the debt through notes that were attached to real estate

Customer:

My parents had several business including motels, apartments, and lending

Customer:

they mostly lent to this one guy

Customer:

but I believe had lent money in the past to others

Customer:

During the bankruptcy settlement, we received some properties back and 10,000 dollars

Customer:

perhaps valued at a 3rd of what my parents had lent him

Lev :

So - your parents actually run business for lending the money - correct?
And they reported interest as their business income - correct?

Customer:

i believe they did report the income yes

Customer:

they had no official business as in business licenses etc for lending

Customer:

no

Customer:

if such things are necessary...

Customer:

the money came from profits of their other businesses including their motels and apartments and house rentals

Lev :

As I mentioned - we need to determine - was that a business loss or investment loss.
Because the loss was form defaulted notes - we need to know if they run a lending business or not.
That is why I am asking - if they reported income from notes as BUSINESS income. Can you verify that? Otherwise - we have to assume that was their investment income/loss.

Customer:

I believe they reported the interest from the notes through their business

Customer:

the income generated from their notes was deposited into bank accounts set up for the LLC

Lev :

Can you verify on which form and which line it was reported? As business income or as an interest income?

Customer:

Hmm right now I do not have their tax return in front of me

Lev :

That is very important for determination of how to treat losses.

Lev :

Ok - so there are two options - if that was a business loss and if that was an investment loss.

Customer:

Okay i see

Customer:

hello

Lev :

Option 1 - if that was a business loss - it is fully deductible in the year the loss occurred. The loss may be fully used to offset other business income. If the loss occurred in 2011 - it should be reported on 2011 tax return.
If the loss is larger that other taxable income - that woudl be NOL - net operating loss.

Customer:

the loss totaling around 3 million would definitely be more that other taxable income

Customer:

in 2011

Customer:

whether something is a business loss or an investment loss means they would be listed under different schedules correct>

Customer:

?

Lev :

If that is 2011 NOL - and you will carry it back to 2010 and 2009 - you need to have your 2011 tax return processed - means if it requires changes besides that NOL - such changes should be done first.
On the other hand - the form 1045 allowed not to amend past tax returns just because of NOL, but since you are amending them anyway - you may choose not to use form 1045 - but simply amend your 2010 and 2009 tax returns.
Any unused portion of NOL is carried forward to 2012. f you carry forward your NOL to a tax year after the NOL year, list your NOL deduction as a negative figure on the Other income line of Form 1040 line 21.

Customer:

hold on, I found the companies 2011 and 2012 tax returns

Customer:

where should I look to find where the bad debt should be listed?

Lev :

In additional - you must attach a statement that shows all the important facts about the NOL. Your statement should include a computation showing how you figured the NOL deduction.


This publication explains how to figure a net operating loss (NOL); when to use an NOL; how to claim an NOL deduction; and how to figure an NOL carryover - www.irs.gov/pub/irs-pdf/p536.pdf‎

Lev :

First of all - we need to know HOW they reported interest income that was received from notes.

Lev :

As I mentioned - we need to determine - was that a business loss or investment loss.
Because the loss was form defaulted notes - we need to know if they run a lending business or not.
That is why I am asking - if they reported income from notes as BUSINESS income. Can you verify that? Otherwise - we have to assume that was their investment income/loss.
Can you verify on which form and which line it was reported? As business income or as an interest income?

Customer:

where would that line be located?

Customer:

under line 10 - bad debts

Customer:

the debt is listed in the 2011 tax return

Lev :

Which form are you looking?

Customer:

1120 s

Lev :

Does that mean - they have S-corporation - not simply a single member LLC as you mentioned?

Customer:

yes, at the top of the return it does say s corp

Customer:

sorry I'm not too familiar with these documents

Lev :

So that corporation had a bad debt - not your parents?
A corporation is a separate legal entity.

Customer:

yes, the corporation

Customer:

can an LLC also be an s-corp?

Lev :

Yes - the LLC may choose to be treated as S-corporation - and that likely what your parents did.

Customer:

ahh okay

Customer:

does that have a different ramification?

Lev :

Ok - so the main question is still - HOW interest income was reported? Can you verify?

Lev :

Yes - that will be different treatment - that is a corporate loss - not the personal loss.

Customer:

likely it was reported as a business income. I would have to verify tomorrow

Lev :

There should be schedule K1 attached to 1022S - do you have it handy?

Customer:

schedule K?

Lev :

It should look like this - http://www.irs.gov/pub/irs-pdf/f1120ssk.pdf

Customer:

line 1 - ordinary business income loss

Customer:

lists the loss

Customer:

*ordinary business income (loss)

Lev :

and there is nothing on line 4 - correct?

Customer:

of the K-1?

Customer:

no, not for 2011

Customer:

but of course, they no longer were receiving interest from the notes at that time

Lev :

did they receive interest income during 2011?

Customer:

no

Lev :

did they receive interest income during 2010?

Customer:

no

Customer:

the guy stopped paying in 2009 i believe

Customer:

yes, in 2009

Lev :

so - how that interest income was reported on 2009 tax return - on form K-1 - was it on line 1 or line 4?

Customer:

I'm not sure. I do not have the 2009 tax return available to me right now

Customer:

I think it would be under ordinary business income likely

Customer:

in 2011 the loss is listed under line 1

Customer:

I apologize that I do not have all the information right now

Lev :

We are talking specifically about interest income received on that note.
I hope - you understand why I am asking? Because the way income was treated will affect how the loss is treated.

Customer:

yes, I understand why you are trying to delineate where the income went to

Customer:

what schedule would the loss be listed under if it were a business income?

Customer:

I assume that the one that we want for the carry loss?

Customer:

investment would only be worth a 3000 deduction?

Lev :

What schedule would the loss be listed under if it were a business income?
As a bad debt - on line 10 from 1120S. Then - the business loss would be passed to shareholders on schedule K-1 line 1.

Customer:

of the first page correct?

Customer:

it is indeed listed under line 1 of the k-1

Customer:

and under line 10 of the 1120 s first page

Lev :

of the first page correct?
Yes. Then - the business loss will be passed to shareholders - and will be reported on 1040 - schedule E. However - deduction is limited by shareholder's basis in S-corporation shares.
If they have significant basis - the loss is deductible, but the basis is reduced by that amount.
Then - a large loss might generate NOL - and all above I said about NOL would be in effect.

Customer:

what is a basis?

Customer:

the percentage they own?

Lev :

The basis is the original investment into S-corporation.

Lev :

The amount of a shareholder's stock and debt basis in the S corporation is very important. Unlike a C corporation, each year a shareholder's stock and/or debt basis of an S corporation increases or decreases based upon the S corporation's operations. The S corporation will issue a shareholder a Schedule K-1.

Customer:

Hmm okay. So, previous to 2010, my mom was the sole managing member of the LLC. She owed 100%

Customer:

Then I became the sole managing member in 2010

Customer:

I now own 100% of the company

Lev :

A shareholder's stock is increased by (using 2011 Form 1120S Schedule K-1 line items):


Schedule K-1
1. Ordinary income Line 1
2. Separately stated income items Lines 2 - 10
3. Tax exempt income Lines 16a & 16b
4. Excess depletion Line 15c


A shareholder's stock basis is decreased, but not below zero, by.


Schedule K-1
1. Ordinary loss Line 1
2. Separately stated loss items Lines 2 - 12d
and 14l, 14m
3. Nondeductible expenses Line 16c
4. Non-dividend distributions Line 16d
5. Depletion for oil and gas Line 17r


 

Customer:

So, will it be possible for me to carry over this bad debt

Customer:

given that hopefully my company will turn a profit now

Lev :

You as a shareholder may not deduct or carry over this bad debt...
That is the bad debt of the corpoiration - not yours.
You as a shareholder may only deduct business losses - in the year such losses are passed to you - and only if losses are larger than your basis.
Then - - assuming losses are deductible - you need to reduce your basis (that is your responsibility to keep track of your basis) and if the loss is more than your other taxable income - you have NOL in that year.

Lev :

If all above are correct - and you had a NOL in 2011 - that NOL should be carried back for two years and the rest will be carried forward for 20 years or until fully used.
That would be a plan of actions. But because claiming NOL might be complicated - I strongly suggest to have a local tax professional helping you with both - corporate and personal tax returns.

Customer:

ahh okay, so I would have to first determined my "basis"

Customer:

and if the loss id larger than said basis

Customer:

so i would definitly say that losing 3 million in notes will likely be larger than my basis

Lev :

Based on your information - the note is owned by the corporation - so that is the corporation will have 3 million loss - not you. Please note that the corporation is a separate legal entity.
You own shares of that corporation - and if the corporation has a large loss - shares will be less valuable - and that is your loss in common sense.
However from tax prospective - your loss is based on your basis - and you may not not lost more than your basis.
Just an example for illustration - if you purchase shares for $1000, but shares value went up to $10000 - there is no taxable gain - as long as you keep shares. If you weer selling shares - you woudl have a taxable gain $9000, but if you keep - no taxable income.
Then shares suddenly went down to $100 - so you may say that you have a huge loss - but there is no loss from tax prospective.

Lev :

So - if you keep shares - there is no loss, but if you sell shares - your loss would be $900 - based on your basis.
Please be aware that is a simplified example - just to illustrate how the basis affect the gain or loss.

Customer:

Oh okay, I understand that.

Customer:

But how does that affect the income make for next year?

Customer:

does it do anything to reduce those taxes?

Lev :

The issue that you have the S-corporation. While the S-corporation is a separate legal entity and files it own tax return - the S-corporation does NOT pay income taxes. S-corporation is so-called a pass through entity.
Instead - any taxable income (or losses) are passed to shareholders - and because you are the only shareholder - to you and reported on K1.
So - each item from K-1 is flow to your individual tax return.

Customer:

so why isn't the loss passed to me?

Customer:

and then when I make a gain next year, I can reduce that gain?

Lev :

That is correct - either income or loss - are passed to you as a shareholder.
Just another example. Assuming you just started S-corporation and invested $1000 of your own money - that is your basis.
Next year - that S-corporation has $3000 income passed to you - which is taxable on your individual tax return. Now your basis is $1000 + $3000 = $4000. But you decide to take $2000 distribution. That distribution would not be taxable - but will reduce your basis $4000 - $2000 = $2000.
Following year - the S-corporation has $1500 loss. That loss is passed to you as a shareholders - and deducted on your personal tax return. But the basis is also adjusted - so your new basis woudl be $2000 - $1500 = $500.

Customer:

okay i'm going to bed soon. Can we continue this tomorrow. It seems you are having trouble connecting

Lev :

Yes - we may continue tomorrow.
My goal is to provide EXCELLENT service. Please be sure you rate accordingly - so I would be credited for my work.

Customer:

OKay sounds good.

Customer:

One last question for now

Customer:

Is there a problem that I submitted my tax returns for 2011 and 2012 this year

Customer:

I wasn't able to do it on time for those year

Customer:

I received an extension for 2012

Lev :

There would be penalty for late filing plus additional penalty if you owe taxes.
If you timely requested an extension for 2012 - you are not late - there still some time to file the tax return - and there would no late filing penalty.
You may ask to abate penalty - but there should be a reasonable cause to get the abatement.

Customer:

hmm yes I did file the extension on time

Customer:

the reason why I ask is because I have had this whole conversation with my accountant

Lev :

So - you are OK for 2012 - but there might be penalty for 2011 tax return.

Customer:

he said that I could not do a carry loss forward because I did not file on time in the year of the loss

Customer:

the bankruptcy settlement that it

Customer:

is

Lev :

If you are talking about your personal tax return - the loss in 2011 will likely generate a NOL. If that is correct - you may not choose it to be carried ONLY forward because that choice must be timely made. But if you carry it two years back - and will carry forward the rest - there should not be any issues.

Customer:

Hmm sorry, can you repeat that. I'm not sure I understand

Lev :

First of all - I assume that you discussed your personal tax return with your accountant - correct?

Customer:

Actually, I you could explain it in a way my accountant would understand that would be awesome. That way I can show it to him.

Customer:

yes

Customer:

we discussed everything

Customer:

and yes he showed me some line that said that the return had to be made in a timely manner

Lev :

You wrote - "he said that I could not do a carry loss forward" - do you mean a loss realized of the corporation or your personal loss?

Customer:

he may have meant for the corporation

Customer:

he said the only reason for it not being able to be carried forward is because the return with the loss had to be filed in a timely manner

Customer:

i think the form might have been a 1045? that I would have had to file

Customer:

not sure

Lev :

That is what I doubt because S-corporation doesn't carry loss - as we already discussed the S-corporation is a pass through entity and doesn't pay income tax - so S-corporation's loss is passed to shareholders. So - if that loss was realized in 2011 - it is passed to shareholders on schedule K1 for 2011.

Lev :

How - you need to prepare your personal 2011 tax return - and use schedule K-1 from S-corporation with other information.

Customer:

I already prepared my 2011 and 2012 personal taxes and sent them in last month

Lev :

Because your 2011 tax return was not timely files - you have to carry the loss back for two years - 2009 and 2010, and only the rest will be carried forward. That means - you need to use form 1045 with your 2011 tax return. If you did not do that - you may amend your 2011 tax return.

Customer:

okay, can you concisely explain all this so I can copy it to show my accountant so he can understand

Lev :

You may use our conversation - print and share with your accountant.
If there are additional questions or there would be additional information - I will verify.
I may talk directly with your account if needed.

Lev :

I may talk directly with your accountant if needed.

Customer:

okay thank you very much

Lev :

You are very welcome. Sorry for confusion.
I provided some examples to help you with understanding.
I do not think your accountant needs these examples - but otherwise we had very a detailed conversation.

Customer:

Okay

Customer:

Can you please just re-explain the timeliness thing and how I can still do the carry loss forward

Lev :

I will try...
Your personal loss based on your information may be in the form of NOL - net operating loss.
Also based on your information the loss is passed to you from the S-corporation on 2011 K1 form as a business loss.
Assuming you had an adequate basis in S-corporation shares - the loss is deductible and your basis of S-corporation shares is reduced by that amount.
That should be reported on your 2011 tax return.
So - that is very important - to determine your basis in S-corporation shares.
Because you have large loss - much larger than your income in 2011 - you had a NOL in 2011.
When your tax return is timely filed - you have a choice to waive the carry back and chose to carry NOL only forward.
But since your 2011 tax return was NOT timely filed - you have to carry the NOL back for two years - 2009 and 2010, and only the rest will be carried forward. That means - you need to use form 1045 with your 2011 tax return. If you did not do that - you may amend your 2011 tax return.
After that - you may use 2011 NOL on your 2012 tax return.
For that - list your NOL deduction as a negative figure on the Other income line of Form 1040 line 21. In additional - you must attach a statement that shows all the important facts about the NOL. Your statement should include a computation showing how you figured the NOL deduction.
That would be generally a list of action as I see your situation.

Customer:

Okay awesome!

Customer:

So can I contact you tomorrow if I or my accountant have questions?

Customer:

what time will you be on?

Lev :

Sure - you may come back tomorrow.
I may not set exact time and I am working with office client. So you might expect delay in responses. But I generally will be available all day.

Customer:

okay sounds good

Customer:

so do I rate now or tomorrow?

Lev :

Well... I prefer to have rating today after more than two hours of conversation.
But if that is an issue - you may do rating tomorrow. I am OK with that.

Customer:

no I'll do it now so long as I can talk to you tomorrow

Lev :

I promise to address all your issues. You may come back any time - not only tomorrow.
As I said - my goal is to provide EXCELLENT service. And all your tax related issues will be addressed the best I could.

Customer:

okay excellent thank you very much

Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22748
Experience: Taxes, Immigration, Labor Relations
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