The recent articles on Revenue Ruling 70-604 generated a number of questions from readers. One of the questions related to how carryovers under Revenue Ruling 70-604 interact with member losses (excessive member expenses over member revenues) calculated under Code Section 277.
The Internal Revenue Service issued Revenue Ruling 2003-73 to explain this issue, providing four examples that illustrate the calculations. Simply stated, an association choosing to file Form 1120 can have only three possible outcomes as it relates to that member income:
- 1)The Association could have an excess of member income over member expenses, which generally is either refunded or rolled over to the following year under the provisions of Revenue Ruling 70-604. If the excess member income is not refunded or carried over to the subsequent year, it’s considered gross income under Code Section 61 and is added to taxable nonmember income.
- 2)It could have an excess of member deductions over member income under Code Section 277, which by law is required to be rolled over to the subsequent year. It may not be carried back, nor may it be used to offset nonmember income.
- 3)It could have exactly $0 net member income, though that outcome is virtually impossible.
The following table is reproduced from Revenue Ruling 2003 – 73.
|
|
Member Income |
Nonmember Income |
Taxable Income |
|
Year 1 |
|
|
|
|
Income/(Loss) before loss carryover |
(2,000) |
4,000 |
|
|
Minus loss carried forward |
0 |
0 |
|
|
Income/(loss) |
(2,000) |
4,000 |
4,000 |
|
Loss carryover |
(2,000) |
|
|
|
|
|
|
|
|
Year 2 |
|
|
|
|
Income/(Loss) before loss carryover |
1,500 |
3,500 |
|
|
Minus loss carried forward |
(2,000) |
0 |
|
|
Income/(loss) |
(500) |
3,500 |
3,500 |
|
Loss carryover |
(500) |
|
|
|
|
|
|
|
|
Year 3 |
|
|
|
|
Income/(Loss) before loss carryover |
2,250 |
3,000 |
|
|
Minus loss carried forward |
(500) |
0 |
|
|
Income/(loss) |
1,750 |
3,000 |
4,750 |
|
Loss carryover |
(0) |
|
|
|
|
|
|
|
|
Year 4 |
|
|
|
|
Income/(Loss) before loss carryover |
1,000 |
(1,500) |
|
|
Minus loss carried forward |
0 |
0 |
|
|
Income/(loss) |
1,000 |
(1,500) |
(500) |
|
Loss carryover (IRC Section 172 loss) |
(0) |
(500) |
|
Note that in Year 1, the member loss cannot be upset against the nonmember income, resulting in the full $4000 of nonmember income being reported as taxable.
In Year 2, the same situation exists in that after applying the member loss carryover from Year 1, there is still a net member loss in Year 2. That cannot be offset against nonmember income, so the $3,500 nonmember income stands alone as being taxable.
In Year 3, a different situation occurs. There is a net member income which is not fully offset by the member loss carryover from Year 2, thus resulting in a net member income in Year 3. This calculation assumes that no election has been made under Revenue Ruling 70-604, so net member income is added to nonmember income and the combined amount is taxable income. Had the Association made an appropriate election under Revenue Ruling 70-604 in Year 3, the net member income of $1,750 would have been either refunded or carried over to the subsequent year and would not be taxable in Year 3.
In Year 4, there is the unusual situation of a net member income of $1,000 and a net nonmember loss of $1,500. This is similar to Year 3 in that member income and nonmember income are both considered taxable and are combined. Please note, however, that member losses may not be offset against nonmember income.
In a subsequent article, we will address additional questions that were raised relating to Revenue Ruling 70-604.
