California Form 3805V: Net Operating Loss Calculation
Gain a clear understanding of Form 3805V for managing a California Net Operating Loss from its initial calculation to its final application.
A net operating loss (NOL) for California purposes occurs when your deductions for the tax year are greater than your income. For individuals, estates, and trusts, this is calculated on Form 3805V, Net Operating Loss (NOL) Computation and NOL and Disaster Loss Limitations. This form determines if a current-year NOL exists and calculates the allowable NOL deduction from losses carried over from previous years.
California’s rules for NOLs differ from federal regulations. A significant distinction is that California does not permit NOL carrybacks, meaning a loss cannot be applied to a prior year’s tax return. Instead, all California NOLs can only be carried forward to offset future income. The duration and percentage of the loss that can be carried forward vary depending on the type of NOL and the year it was generated.
Determining if You Have a California Net Operating Loss
A California NOL is common for sole proprietors, partners, LLC members, and beneficiaries of estates or trusts with business activities. The loss from the business activity flows through to the individual’s personal tax return. To determine if you have an NOL, you must first categorize your income and deductions as either business or nonbusiness.
Business income is derived from a trade or business, such as the net profit or loss on a federal Schedule C or E. Nonbusiness income includes items like wages, interest, and dividends. Similarly, business deductions are those directly related to business operations, while nonbusiness deductions include the standard deduction or itemized deductions like mortgage interest on a personal residence.
This distinction is important because nonbusiness deductions can only be subtracted from nonbusiness income. If your nonbusiness deductions exceed your nonbusiness income, the excess cannot be used to increase your NOL. The NOL is a measure of your net loss from business activities after all other income sources have been accounted for.
Calculating the Current Year Net Operating Loss
To calculate a current year NOL, you must complete Part I of Form 3805V. This requires figures from your federal and state tax returns, including your federal adjusted gross income (AGI) and your completed California Schedule CA (540).
The calculation begins in Part I, Section A for full-year residents, starting with your California AGI from Form 540. From this amount, you must make several adjustments to isolate the business loss that qualifies for the NOL. California law requires you to add back certain deductions that are not allowed for NOL purposes, including any prior year NOL deduction claimed, nonbusiness capital losses exceeding nonbusiness capital gains, and nonbusiness deductions exceeding nonbusiness income.
The final figure in Part I represents your current year NOL, which can be carried forward. Part-year residents and nonresidents follow a similar process in Section B but must allocate their income and deductions based on the period of California residency.
Calculating Your NOL Carryover and Deduction
Part II of Form 3805V is used to calculate the amount of prior-year NOLs that can be deducted on your current year’s tax return. This section is relevant only if you have an existing NOL carryover. The primary purpose of Part II is to determine your modified taxable income (MTI), which is your taxable income for the current year before you subtract any NOL carryover.
You begin by listing your NOL carryovers from prior years in the table provided in Part III. You must enter the year the loss was incurred, the type of loss, and the remaining carryover amount. The table helps you track different types of NOLs, as they may have different carryover periods and percentage limitations. For instance, general NOLs can be carried over for 20 years, but the deductible amount might be limited to a percentage of the loss.
Once you determine your MTI, you apply this amount as a limit to your available NOL carryovers. The allowable deduction is the lesser of your total available NOL carryover or your MTI. After calculating the deduction, you must also calculate the remaining NOL amount to be carried over to future years by subtracting the amount used in the current year from the available carryover.
Special Rules for Disaster Losses
Part III of Form 3805V also addresses losses incurred from a disaster officially declared by the Governor of California. These disaster losses receive more favorable tax treatment than general NOLs, primarily through generous carryover provisions.
Unlike a regular NOL, a disaster loss can often be carried forward with a 100% allowance, meaning the full amount of the loss can be used to offset future income. The carryover period for disaster losses is also extended, sometimes for up to 20 years, depending on the specific disaster. The instructions for Form 3805V provide a list of designated disasters and the specific carryover rules that apply to each.
When completing the form, you must separately identify the disaster loss, noting the specific event and the year of the loss. This ensures that the special carryover rules are applied correctly and that the disaster loss is not commingled with any general NOLs, which are subject to different limitations.
Applying the NOL Deduction to Your Tax Return
After completing Form 3805V, the final step is to report the result on your main California tax return. The calculated NOL deduction from Part II is entered on Schedule CA (540), Part I, Section B, line 9b2, as a subtraction. This entry reduces your California adjusted gross income and lowers your overall tax liability.
You must attach the completed Form 3805V to your California tax return, whether you file electronically or by mail. The Franchise Tax Board uses the form to verify your NOL calculation and track your carryover amounts. Failure to attach the form can result in processing delays or a disallowance of the deduction.
Finally, you must retain a copy of the completed Form 3805V for your records. This is necessary for accurately calculating your NOL carryover in future tax years, as you will need the prior year’s form to report the remaining carryover amount.