What NOL Will Not Reduce

Net Operating Losses (commonly known as NOL) is not one of those terms that are not familar to most taxpayers and it would take an enormous amount of time to explain in detail.

Most NOLs are a result of your deductions (capital losses, investment losses and as a result of negative K-1 passive income) exceeding your income, i.e. net operating loss.

Here's an example:

You have a self-employed (1099-MISC) individual who also has losses from a K-1 he receives as a partner of a corporation (1120S or 1065). The individual had $10,000 income reported on his Schedule C which also results in tax due on his earnings plus self-employment tax (social security tax). Individual receives a K-1 with a $125,000 loss.

First of all, the tax due as a result of the Schedule C income will be eliminated by the K-1 loss but will not eliminate the self-employment tax.

NOL will not reduce or eliminate or having to pay self-employment tax.

Since the net loss from the K-1 was $125,000 then deduct the amount of tax due on the self-employment income (not the self-employment tax) and whatever is left can be carried over indefinitely and can be used in future years to offset taxable income.

You also have to remember that Social Security tax is not paid to the IRS but rather is paid to the Social Security Administration and is deposited into your personal social security account for your retirement.

W-2 wage earners pay Social Security tax through their paychecks but self-employed taxpayers have to pay the tax themselves on their returns.

Look at it this way, yes, you have to pay the self-employment tax as it is mandatory, but who are you really paying......yourself!