462 MODULE 33 TAXES: INDIVIDUAL
ness of lending money, nor was the loan required as a con-
dition of Cook's employment. Since Cook owned no stock
in Precision, the loss could not be deemed to be a loss from
worthless stock, deductible as a long-term capital loss.
69. (b) The requirement is to determine the amount of
gifts deductible as a business expense. The deduction for
business gifts is limited to $25 per recipient each year.
Thus, Palo Corporation's deduction for business gifts would
be [(4 x $10) + (13 x $25)] == $365.
I.E.3 Net Operating Loss (NOL)
70. (b) The requirement is to determine Jennifer's net
operating loss (NOL) for 2009. Jennifer's personal casualty
loss of $45,000 incurred as a result of the destruction of her
personal residence is allowed as a deduction in the compu-
tation of her NOL and is subtracted from her salary income
of $30,000, to arrive at a NOL of $15,000. No deduction is
allowed for personal and dependency exemptions in the
computation of a NOL. . by owner-employees. Since passive activity income, losses,
71. (c) The requirement is to determine the amount of
net operating loss (NOL) for a self-employed taxpayer for
2009. A NOL generally represents a loss from the conduct
of a trade or business and can generally be carried back two
years and forward twenty years to offset income in the car-
ryback and carryforward years. Since a NOL generally
represents a business loss, an individual taxpayer's personal
exemptions and an excess of nonbusiness deductions over
nonbusiness income cannot be subtracted in computing the
NOL. Nonbusiness deductions generally include itemized
deductions as well as the standard deduction if the taxpayer
does not itemize. In this case, the $5,700 standard deduction
offsets the $1,500 of nonbusiness income received in the
. form of dividends and short-term capital gain, but the excess
($4,200) cannot be included in the NOL computation. Thus,
the taxpayer's NOL simply consists of the $6,000 business
loss.
72. (a) The requirement is to determine Destry's net
operating loss (NOL). A net operating loss generally repre-
sents a loss from the conduct of a trade or business and can
generally be carried back two years and forward twenty
years to offset income in the carryback and carry forward
years. Since a NOL generally represents cl business loss, an
individual taxpayer's personal exemption and an excess of
nonbusiness deductions (e.g., standard deduction) over non-
business income (e.g., interest from savings account) cannot
be subtracted in computing the NOL. Similarly, no deduc-
tion is allowed for a net capital loss. As a result, Destry's
NOL consists of his net business loss of $16,000 reduced by
his business income of $5,000 from wages and $4,000 of net
rental income, resulting in a NOL of $7,000.
I.E.6. Losses and Credits from Passive Activities
73. (a) The requirement is to determine the amount of
Cobb's rental real estate loss that can be used as an offset
against income from nonpassive sources. Losses from pas-
sive activities may generally only be used to offset income
from other passive activities. Although a rental activity is
defined as a passive activity regardless of the owner's par-
ticipation in the operation of the rental property, a special
rule permits an individual to offset up to $25,000 of income
that is not from passive activities by losses from a rental real
estate activity if the individual actively participates in the
rental real estate activity. However, this special $25,000
allowance is reduced by 50% ofthe taxpayer's AGI in ex-
cess of $100,000, and is fully phased out when AGI exceeds
$150,000. Since Cobb's AGI is $200,000, the special
$25,000 allowance is fully phased out and no rental loss can
be offset against income from nonpassive sources.
74. (c) The requirement is to determine the entity to
which the rules limiting the allowability of passive activity
losses and credits applies. The passive activity limitations
apply to individuals, estates, trusts, closely held C cor-
porations, and personal service corporations. Application of
the passive activity loss limitations to personal service cor-
porations is intended to prevent taxpayers from sheltering
personal service income by creating personal service corpo-'
rations and acquiring passive activity losses at the corporate
level. A personal service corporation is a corporation
(1) whose principal activity is the performance of personal
services, and (2) such services are substantially performed
and credits from partnerships 'and S corporations flow
through to be reported on the tax returns of the owners of
such entities, the passive activity limitations are applied at
the partner and shareholder level, rather than to partnerships
and S corporations themselves.
75. (c) The requirement is to determine Wolf's passive
loss resulting from his 5% general partnership interest in
Gata Associates. A partnership is a pass-through entity and
its items of income and loss pass through to partners to be
included on their tax returns. Since Wolf does not materi-
ally participate in the partnership's auto parts business,
Wolf's distributable share of the loss from the partnership's
auto parts business is classified asa passive activity loss.
Portfolio income or loss must be excluded from the compu-
tation of the income or loss resulting from a passive activity,
and'must be separately passed through to partners.
Portfolio income includes all interest income, other
than interest income derived in the ordinary course of a
trade or business. Interest income derived in the ordinary
course of a trade or business includes only interest income
on loans and investments made in the ordinary course of a
trade or business of lending money, and interest income on
accounts receivable arising in the ordinary course of a trade
or business. Since the $20,000 of interest income derived
by the partnership resulted from a temporary investment, the
interest income must be classified as portfolio income and
cannot be netted against the $100,000 operating loss from
the auto parts business. Thus, Wolf will report a passive
activity loss of $100,000 x 5% == $5,000; and will report
portfolio income of $20,000 x 5% == $1,000.
76. (a) The requirement is to determine tpe correct
statement regarding the passive loss rules involving rental
real estate activities. By definition, any rental activity is a
passive activity without regard as to whether or not the tax-
payer materially participates in the activity. Answer (b) is
incorrect because interest and, dividend income not derived
in the ordinary course of business is treated as portfolio
income, and cannot be offset by passive rental activity
losses when the "active participation" requirement is not
met. Answer (c) is incorrect because passive rental activity
credits cannot be used to offset the tax attributable to non-
passive activities. Answer (d) is incorrect because the pas-
sive activity rules contain no provision that excludes tax-