As the end of 2009 approaches, companies with operating losses from the past two years have a big decision to make: whether to take advantage of the new net operating loss (NOL) carryback rules that were signed into law in November. To put more cash into the coffers of American businesses, Congress extended the carryback period for losses incurred in 2008 or 2009 from two years to five years. All companies are eligible for the extension, except those that received bailout money from the government under the Troubled Asset Relief Program.
The new rules, part of the Worker, Homeownership, and Business Assistance Act of 2009, are similar to those passed last February for small companies (those with sales of $15 million or less). Companies can use the expanded carryback period for NOLs incurred in either 2008 or 2009, but not both. Small companies may take advantage of the newer legislation provided they don’t use losses from the same year twice. If a small company has already applied an NOL from 2008 to a prior taxable year, only a loss from 2009 can be carried back.
On November 20, as a follow-up to the legislation, the Internal Revenue Service issued guidance for claiming a tax refund based on the carryback. For example, a company can claim a refund either on its tax return, on the refund-claim form provided by the IRS, or by amending its prior tax return. These are the same options previously offered to small companies in February.
Companies must answer two basic questions concerning the new rules: which year’s NOL should they carry back, and how far back should they carry it? The challenge for finance executives will be to weigh different NOL-carryback scenarios to determine “the ancillary effects” on other elements of their tax returns, says Paul Manning, a principal-in-charge in KPMG’s tax practice.
For example, if a company carries back a loss to a year in which foreign tax credits were used — and the carryback wipes out the taxable income for that year — there may be no need to use the credits. In that case, a company may have the ability, subject to the tax code, to move the credits into another taxable year and amend its returns accordingly. Alternatively, the taxpayer might choose to deduct the foreign taxes instead of taking a credit for them. (In general, foreign tax credits are good for 10 years.)
Another area companies may want to consider with respect to NOL carrybacks is Section 199 of the tax code, which deals with what is broadly defined as manufacturing activities, says David Culp, a senior manager in KPMG’s national tax practice. During the past few years, Section 199 has allowed a deduction for a percentage of income generated by manufacturing activities, he says. But the deduction isn’t allowed to create or produce an NOL. As a result, a company that has taken a Section 199 deduction equal to, say, 3% of its 2005 taxable income may not want to carry back recent losses to 2005 under the new law — at least until it assesses whether using the new carryback is worth more than forfeiting the Section 199 deduction, says Culp.
Similarly, the five-year carryback provision may affect a company’s ability to use general business credits, such as the research credit (used to encourage business innovation) or the work opportunity credit (used to encourage companies to hire unemployed veterans or young persons not attending school). It may also force companies to recalculate tax benefits tied to the alternative minimum tax. In most cases, companies can move around tax benefits and apply deductions and credits to other years, says Culp, who points out that NOLs can be carried forward for up to 20 years from the date the loss originates. “The point is, you have to look carefully at the circumstances,” he says.
Experts say the IRS guidance comes up short in one area: how the new rules affect recently acquired companies. It’s unclear where the agency stands regarding the acquisition of a stand-alone company that has already made an election to use an NOL from 2008 or 2009. Is the new parent banned from choosing the same loss year? Or, if the parent has already filed for a refund in the same year as the newly acquired company, is one of the companies required to forfeit the refund?
The IRS has suggested that it will consider providing additional guidance in this area, but the timing for doing so is vague. “It would be nice to hear from the IRS on this issue, so we could gain some certainty [about the new legislation],” says Culp.