What is IRS Publication 536

IRS Publication 536 is a document published by the Internal Revenue Service (IRS) that provides guidance on what to do when a taxpayer, whether an individual or corporation, has more deductions than income in a given tax year. If the total deductions a taxpayer claims are greater than that taxpayer's income for the year, the taxpayer is said to have a net operating loss. 

BREAKING DOWN IRS Publication 536

IRS Publication 536 reviews how to calculate a net operating loss. By definition, a net operating loss occurs when a company's allowable tax deductions exceed its taxable income. Typically, deductions must be the direct result of trade or business; an employee’s work; casualty and theft losses; moving expenses; or rental property. 

The following items are not allowed to be included: Any deduction for personal exemptions; capital losses in excess of capital gains; the section 1202 exclusion of the gain from the sale or exchange of qualified small business stock; nonbusiness deductions in excess of nonbusiness income, the net operating loss deduction; and the domestic production activities deduction.

A net operating loss for the company can be used to recover past tax payments. This allows the company to garner some measure of tax relief when it incurs losses. In such cases, they may be able to apply the net operating loss to future income tax. A business is allowed to carry the taxable amount back to the two previous years and apply it against taxable income for a refund. 

IRS Publication 536 does not apply to bankruptcy scenarios. It also does not apply to losses incurred by partnerships or S Corporations. However, individual partners or S corporation shareholders are allowed to use the income or deductions from their personal shares as part of the calculation of their individual net operating loss. 

Publication 536 and Calculating Net Operating Losses

On the IRS website, Publication 536 breaks down the net operating loss process into five steps.

  1. Complete the tax return for the year. A net operating loss may be part of that year’s return if a negative amount appears on the following lines: For individuals, Form 1040, line 41, or Form 1040NR, line 39; and for estates and trusts, see the instructions for Form 1041, line 22.
  2. Note the amount of the net operating loss per the IRS’ guidelines. 
  3. Determine whether to carry the net operating loss back to a previous year or waive the carryback period and carry the loss forward. 
  4. Deduct the net operating loss in the carryback or carryforward year. Not that the net operating loss must be used if the deduction is equal to or less than the taxable income amount. 
  5. Determine the amount of the unused net operating loss and carry it to the next carryback or carryforward. 

Given the many rules and exceptions that may apply, it is always a prudent decision to consult the IRS or a qualified tax accountant when calculating and applying net operating losses.