Self-employment income couldn't be offset with an NOL carryforward 

The Tax Court has concluded that an accountant was prohibited from offsetting his net earnings from self-employment with an net operating loss (NOL) carryforward.

Background. A taxpayer's self-employment income is subject to self-employment tax. The tax, which is assessed and collected as part of the income tax, must be included in computing any income tax deficiency or overpayment, and must be taken into account for estimated tax purposes.

Self-employment income is generally defined as the net earnings from self-employment derived by an individual. Specifically, defines “net earnings from self-employment” as “the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss from any trade or business carried on by a partnership of which he is a member; except that in computing such gross income and deductions and such distributive share of partnership ordinary income or loss—”

The above language followed by an enumerated list of specific rules (i.e., primarily exclusions) in computing net earnings from self-employment, including the following excerpted language:

(4) the deduction for net operating losses provided in Code Sec. 172 shall not be allowed;

(5) if—

(A) any of the income derived from a trade or business (other than a trade or business carried on by a partnership) is community income under community property laws applicable to such income, the gross income and deductions attributable to such trade or business shall be treated as the gross income and deductions of the spouse carrying on such trade or business...and

(B) any portion of a partner's distributive share of the ordinary income or loss from a trade or business carried on by a partnership is community income or loss under the community property laws applicable to such share, all of such distributive share shall be included in computing the net earnings from self-employment of such partner...

Parties' position. Decrescenzo contended it did not apply to individuals but instead applied only to partnerships. He contended that, because paragraph 5 of Code Sec. 1402(a) begins with the word “if,” paragraph 4 of Code Sec. 1402(a) is applicable only if the taxpayer meets the requirements of either subparagraph (A) or (B) of Code Sec. 1402(a)(5). On the other hand, IRS maintained that paragraphs (1) through (17) of Code Sec. 1402(a) set out specific rules for computing net earnings from self-employment and that each numbered paragraph contains a separate rule. Thus, paragraph (4) of Code Sec. 1402(a) operates independently of paragraph (5) of Code Sec. 1402(a), and its application isn't dependent on the taxpayer's satisfaction of subparagraph (A) or (B) of Code Sec. 1402(a)(5).

Facts. Joseph Decrescenzo was an accountant who in 2006 received nonemployee compensation of $137,6603 from his accounting business. He failed to timely file a Form 1040, (opps, he forgot ) U.S. Individual Income Tax Return, for 2006.

IRS prepared a substitute return under Code Sec. 6020(b) and determined a deficiency. On the Schedule SE, Self-Employment Tax, IRS determined that Decrescenzo had received $131,660 in self-employment income and that he owed self-employment tax of $15,207.

Decrescenzo filed a timely petition for redetermination of the deficiency. The parties stipulated that Decrescenzo had an NOL carryforward from prior years. Decrescenzo did not claim the NOL carryforward until after IRS issued the notice of deficiency. While IRS and Decrescenzo agreed that he could reduce his total income by $51,065—the amount of the NOL carryforward—they disagreed as to whether he could also use the NOL carryforward to offset his self-employment income.

Computing net earnings from self-employment. The Tax Court prohibited Decrescenzo from using his $51,065 NOL carryforward to reduce his net earnings from self-employment. Reg. § 1.1402(a)-7 provides that for purposes of determining self-employment income, the deduction provided by Code Sec. 172, relating to NOLs sustained in years other than the tax year, is excluded. The Tax Court also noted that it had repeatedly reached this same conclusion. 

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