Rule: A Net Operating Loss (NOL) exists if there is a net loss on the following tax returns:

• Form 1040, Line 41 for Individuals

• Form 1041, Line 22 for Estates and Trusts

• Form 1120, Line 28 for Taxable C Corporations

A net operating loss exists on tax returns of taxable entities.

Choice "c" is correct. Per the above rule, trusts and estates are entitled to a net operating loss deduction. Trusts and estates can be taxable entities, even though, at times, they may also have pass-through effects.

Choice "a" is incorrect. Partnerships are pass-through entities; thus, they do not pay tax at the entity level. Therefore, NOLs are not allowed at the partnership level. [Note: If the partnership has a pass-through loss, however, an NOL may exist, for example, on the personal tax return of an individual partner.]

Choice "b" is incorrect. S corporations are pass-through entities; thus, they do not pay tax at the entity level. Therefore, NOLs are not allowed at the S corporation level. [Note: If the S corporation has a pass-through loss, however, an NOL may exist, for example, on the personal tax return of an individual shareholder.]

Choice "d" is incorrect. Not-for-profit organizations are not taxable entities (although they may generate some taxable income, called unrelated business taxable income); therefore, they do not generate net operating losses, unless it is only for the unrelated business taxable income effect (which may create an NOL for the unrelated business taxable income portion only). Thus, choice "a" is the best answer to this question.