Reading ain’t easy. If it were, kids’ menus wouldn’t have pictures of grilled cheese on them, thousands of co-eds wouldn’t have been handed diplomas from the University of “Wisconson,” and hundreds of millions of Catholics wouldn’t have been ordered to cheat on their spouses by the 1632 version of the King James Bible.
Comprehension challenges are only exacerbated when the subject material is the Internal Revenue Code, where meandering cross-references and exceptions to exceptions complicate matters for even the most attentive and astute among us.
Consider the case of Joseph Decrescenzo (Decrescenzo), an accountant who made his living in the bowels of the IRC. Decrescenzo recognized $137,660 of income from his accounting business on his 2006 Schedule C, before partially offsetting the income with a $51,065 net operating loss (NOL) carryover from prior years.
In addition to utilizing the NOL for the purpose of computing his taxable income, Decrescenzo also reduced his self-employment income by the NOL for the purpose of determining his liability for self-employment tax. The IRS permitted the reduction in Decrescenzo’s taxable income for the NOL, but denied the use of the NOL in offsetting his self-employment income.
In deciding whether Decrescenzo was entitled to reduce his self-employment income by the NOL, it wasn’t necessary for the Tax Court to analyze decades of case history in search of a relevant authority; rather, the court was required to simply settle a dispute as to the proper reading of the governing Code section.
The statute defines self-employment income in I.R.C. § 1402(a), with modifications in the subparagraphs that follow. Section 1402 reads as follows:
I.R.C. § 1402(a) Net Earnings From Self-Employment.–The term “net earnings from self-employment” means 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…except that in computing such gross income and deductions –
The relevant modifications include the following subparagraphs:
(4) the deduction for net operating losses provided in section 172 shall not be allowed.
(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.
In arguing that he was entitled to offset his self-employment income with his NOL, Decrescenzo interpreted I.R.C. § 1402(a)(4) to apply only to self-employment income earned from partnerships. He based this contention on the construction of the statute, arguing that because subparagraph (5) started with the word “if,” subparagraph (4) served to deny the use of an NOL only if the requirements of (5)(A) or (B) were met. A reasonable interpretation that, quite honestly, I agreed with at first blush.
According to the Tax Court, however, both Decrescenzo’s and my reading of the statute were wrong. The court held that each numbered subparagraph stands on its own in providing guidance for computing self-employment income. Thus, the plain language of I.R.C. § 1402(a)(4) serves to deny the use of any NOL in determining self-employment income, completely independent of I.R.C. § 1402(a)(5).