Memorandum; November 20, 1991; CONTROL NO.: II 11-91-4-P

Topic Code: N026Net Operating Loss          Document Reference:

MEMORANDUM CONTROL NO.: II 11-91-4-P

TO: RHONDA, KIRKPATRICK, SUPERVISOR, INDIVIDUAL AUDIT SECTION

FROM: JAMES D. HAMILTON, TAX SPECIALIST, POLICY SECTION

DATE: November 20, 1991 RE: ARE REPAYMENTS OF DISABILITY SICK PAY CONSIDERED TO BE BUSINESS DEDUCTIONS FOR PURPOSES OF COMPUTING A NET OPERATING LOSS

STATUTES AND RULES: Iowa Code § 422.7(5) and 422.9(3)

FACTS: The taxpayer had previously filed Iowa returns for 1987 and 1988 on which the taxpayer included in the Iowa net incomes for the tax years disability sick pay benefits shown on W-2s for those years. The taxpayers claimed the disability income exclusion as an adjustment to income on both of the returns. Thus, not all the disability benefits shown on the W-2s for the two years were taxed on the returns.

Sometime in 1991, the taxpayers amended returns for 1987 and 1988 on the basis of repayment of the disability sick pay benefits in 1990 which had been included in incomes in 1987 and 1988. The repayment of the benefits was shown as creating a net operating loss in 1990 which the taxpayers tried to carry back to the 1987 and 1988 tax years. The revenue examiner in the Individual Audit Section denied the refunds on the basis that repayments were related to non-business income so the repayments could not generate a net operating loss.

DETERMINATION: The repayment of disability sick pay benefits in a tax year can result in a net operating loss if the amount repaid exceeds the taxpayer's income in the year of repayment. The Federal Tax Coordinator on page 36,266 describes nonbusiness deductions for non-corporate taxpayers as deductions that are not attributable to the taxpayer's trade or business and are not attributable to the taxpayer's employment. (Emphasis supplied). The disability sick pay benefits were originally reported on W-2 forms from J. I. Case Company of Racine, Wisconsin. Therefore, I believe that the disability sick pay payments received by the taxpayer are related to the taxpayer's employment with J. I Case or prior employment with that company. Assuming the taxpayer repaid those benefits, I believe we must consider the repayment as a "business deduction", so the deduction can result in a net operating loss for the year of repayment.

However, before we allow the net operating loss for the 1990 tax year and a carryback to 1987 and 1988, the taxpayer must provide proof of the repayment. In addition, if the repayment is verified, the portion of the repayment deduction that was not taxable to Iowa because of the disability income exclusion in Iowa Code § 422.7(5) should not be allowed.

Attached are two pages from the Federal Tax Coordinator which describe business and nonbusiness deductions for purposes of computing a net operating loss.

James D. Hamilton