Revenue Administrative Bulletin 1993-9

Approved: June 25, 1993

INCOME TAX -
 REPORTING AND UTILIZING A NET OPERATING LOSS FOR MICHIGAN INCOME TAX AND HOUSEHOLD INCOME PURPOSES

(Replaces Revenue Administrative Bulletin 1989 - 60)

RAB-93-9. This bulletin describes how a net operating loss (NOL) is used and reported for Michigan income tax and household income purposes in view of the Court of Appeals decision in Preston v Treasury, 190 Mich. App 491; 476 NW 2d 455, (August 5, 1991); lv den 439 Mich. 980.

The Michigan Income Tax Act provides for a net operating loss. A net operating loss (NOL) is the excess of allowable deductions over gross income, subject to certain adjustments. The most common reason for the appearance of an NOL is a loss from the operation of a business. However, an NOL may also be caused by excess employee business deductions or deductions taken for casualty or theft losses.

Michigan Income Tax Treatment

In 1987 the Michigan Income Tax Act was amended by Public Act Number 254 to limit the statutory NOL deduction in calculating Michigan taxable income. The amendment added subsections (p) and (q) [now (o) and (p)] to section 30 of the Act, MCL 206.30(1)(o) and (p); MSA 7.557(130). These subsections provide:

"(o) Add to the extent deducted in determining federal adjusted gross income the net operating loss deduction under section 172 of the internal revenue code."

"(p) Deduct a net operating loss deduction for the taxable year as defined in section 172 of the internal revenue code subject to the modifications under section 172(b)(2) of the internal revenue code and subject to the allocation and apportionment provisions of chapter 3 of this Act for the taxable year in which the loss occurred."

To calculate Michigan taxable income a taxpayer must begin with "adjusted gross income" as defined in the Internal Revenue Code MCL 206.30(1); MSA 7.557(130). Assuming there are no modifications to adjusted gross income other than a net operating loss deduction, the taxpayer adds the federal NOL deduction back to adjusted gross income on the Michigan return. After the federal NOL deduction has been added back, the statute provides for the subtraction of a Michigan NOL deduction MCL 206.30(1)(p); MSA 7.557(130).

Determining the Michigan NOL Deduction

A taxpayer having no income or losses from states other than Michigan will have a Michigan NOL deduction limited to the smaller of:

1. The federal NOL deduction, or

2. The federal NOL deduction less the portion of the federal NOL deduction being carried to the next tax year under the provisions of section 172(b)(2) of the Internal Revenue Code. This amount is referred to as federal modified taxable income. Federal modified taxable income is arrived at by calculating federal taxable income without regard to the net operating loss deduction, the capital loss deduction, and the federal exemption allowance. (Refer to Federal publication 536 for additional information.)

Allocation and Apportionment of the Federal NOL Deduction

A taxpayer having income and/or losses subject to the allocation and apportionment provisions of chapter 3 of the Michigan Income Tax Act [beginning at MCL 206.102; MSA 7.557(1102)], must recalculate the federal net operating loss, the federal net operating loss deduction and federal modified taxable income without regard to income, losses and deductions attributable to other states. The Michigan NOL deduction will be the lesser of the federal NOL deduction (computed without income and losses from other states) or federal modified taxable income (computed without income or losses from other states).

Michigan NOL in the Absence of a Federal NOL

The Michigan Court of Appeals ruled in Preston, supra, that a taxpayer may have a Michigan net operating loss in the absence of a federal net operating loss. The Michigan NOL is computed in accordance with the federal NOL provisions of section 172 of the Internal Revenue Code, using only income, losses and deductions allocated or apportioned to Michigan under chapter 3 of the Michigan Income Tax Act. The NOL may be carried over or back to other tax years in the same manner as allowed under section 172(b)(1) of the Internal Revenue Code.

In the absence of a federal NOL deduction, the Michigan NOL deduction may not exceed modified federal adjusted gross income computed without regard to income and losses from other states.

A taxpayer may file amended returns for tax periods within the four-year statute of limitations to claim a refund of any overpaid taxes as the result of the application of a Michigan NOL deduction.

Carry-back and Carryover of the Net Operating Loss

A net operating loss may be carried back three years and carried over to each of the subsequent 15 years until the loss is completely offset. A taxpayer may also elect to forego a carry-back and to carry over the NOL for the subsequent 15 years. (See Internal Revenue Code section 172(b)(1)(a) and (b). A Michigan taxpayer must carry back or carryover the NOL to the same tax years as was elected for federal tax purposes. Michigan does not require a separate election regarding the carry-back or carryover of a Michigan NOL. However, in the absence of a federal NOL, an election must be made at the Michigan level. The election is made by attaching a statement to the Michigan return.

Reporting Requirements and Forms

A Michigan taxpayer claiming a net operating loss deduction created by a carry-back or carryover of an NOL must complete form MI1045 APPLICATION FOR A NET OPERATING LOSS REFUND and attach the form to the MI1040 or MI1040X. This form and instructions explain how to compute an NOL, federal modified taxable income in the year the NOL deduction is taken, a refund for a carry-back year, and an NOL carryover.

To expedite the review of tax returns reflecting an NOL deduction, the Department requests that taxpayers attach copies of the federal forms 1045, 1040 and schedule A, and any other pertinent form or data related to calculating the NOL.

The Michigan MI-1045 form and instructions may be obtained by telephoning the Michigan Department of Treasury at 1800-FORM-2-ME. The Department of Treasury recommends the use of Federal Treasury Publication 536 in calculating an NOL.

Household Income Treatment

The Michigan Income Tax Act was amended in 1987 by Public Act 254 to eliminate the net operating loss deduction in calculating household income. The Act was amended again in 1988 by Public Act 261 to restore a limited NOL deduction in calculating household income. The amendment provides that, beginning with the 1988 tax year, a deduction for a carry-back or carryover of a net operating loss shall not exceed federal modified taxable income as defined in section 172(b)(2) of the Internal Revenue Code MCL 206.510(1); MSA 7.557 (1510) (1). The deduction is limited to the lesser of federal modified taxable income or the federal NOL deduction.

For tax years before 1988, the entire NOL deduction used to reduce federal adjusted gross income shall be used as a deduction in calculating household income. Household income is used for the calculation of the homestead property tax credit, the home heating credit, farmland preservation credit, and the senior citizen prescription drug credit.

Sample Calculations

The following examples illustrate the calculation of the Michigan NOL deduction in each of the three distinct conditions addressed in this bulletin.

Example 1 (All Income and Losses Attributable to Michigan)

In 1991, the taxpayer, a Michigan resident, has a Michigan business loss of ($50,000), wages of $20,000, and a standard deduction of ($3,400). The taxpayer's federal and Michigan NOLs will both be ($30,000).

In 1992, the taxpayer has business income of $10,000 from a Michigan business, wages of $15,000, a federal NOL deduction of ($30,000), and a standard deduction of ($3,600). The taxpayer's 1992 federal adjusted gross income will be ($5,000).

1992 federal modified taxable income is calculated as follows:

For purposes of computing both Michigan taxable income and household income, the taxpayer's 1992 Michigan NOL deduction will be ($21,400). This is the same as federal modified taxable income, as all business activity is within Michigan. The NOL carryover to 1993 for both Michigan and federal purposes will be ($8,600) [($30,000) - ($21,400)].

The 1992 Michigan income tax liability is calculated as follows:

Example 2 (Apportionment of Federal NOL Deduction)

In 1991, the taxpayer, a Michigan resident, has a Michigan business loss of ($50,000), wages of $30,000, rental losses of ($20,000) from other states, and a standard deduction of ($3,400). The taxpayer's 1991 federal NOL will be ($40,000), and the 1991 Michigan NOL will be ($20,000) [($50,000) plus ($30,000)].

In 1992, the taxpayer has wages of $10,000, Michigan business income of $10,000, rental income of $5,000 from other states, a federal NOL deduction of ($40,000), and a standard deduction of ($3,600). The taxpayer's 1992 federal adjusted gross income will be ($15,000).

1992 federal modified taxable income and the related 1992 Michigan NOL deduction are calculated as follows:

For purposes of computing Michigan taxable income, the taxpayer's 1992 Michigan NOL deduction will be ($16,400). For household income purposes, the allowed NOL deduction will be ($21,400). The federal NOL carryover to 1993 will be ($18,600) [($40,000) - ($21,400)]. The Michigan NOL carryover to 1993 will be ($3,600) [($20,000) - ($16,400)].

The 1992 Michigan tax liability is calculated as follows:

Example 3 (Michigan NOL in the Absence of a Federal NOL)

In 1991, the taxpayer, a Michigan resident, has wages of $10,000, a business loss from Michigan sources of ($30,000), a capital gain of $50,000 from the sale of real estate located in another state, and a standard deduction of ($3,400). For federal tax purposes the taxpayer has not sustained an NOL, but has sustained a Michigan NOL of ($20,000).

In 1992, the taxpayer's only income is wages of $15,000 and a standard deduction of ($3,600).

The taxpayer's 1992 Michigan NOL deduction is ($15,000), and the Michigan NOL carryover to 1993 is ($5,000). The taxpayer's 1992 Michigan income tax liability will be zero. For household income purposes, no 1992 NOL deduction would be allowed.