Your Loss Is Your Gain

Uncle Sam has extended the time frame for loss carrybacks. Should you take advantage?

When companies closed their books on 2008, the financial crisis made itself very apparent: 3,700 publicly held corporations reported losses, a 9% increase over the previous year. Enter Congress, which offered a corporate tax break on a scale not seen since the aftermath of the terrorist attacks of September 11, 2001.

Last November, lawmakers ordered the Internal Revenue Service to temporarily amend the tax code to give all companies more flexibility in turning net operating losses (NOLs) into cash.

The tax-code alchemy conjured up by Congress and the Treasury Department extended what is known as the NOL carryback period, stretching it from two years to five for corporate losses incurred in 2008 and 2009. That means that corporate losses reported in those two years can be used to offset taxable income already reported during the prior five years.

In practical terms, that means companies can file for a cash refund from Uncle Sam for taxes they’ve already paid. And they can now do so for years that saw the highest corporate profits in the nation’s history — 2005 and 2006 — when an aggregate $3.4 trillion in corporate profits was reported.

But weighing the benefits of the immediate cash infusion against the irreversible decision to forgo other potential tax benefits and credits is no simple matter. Although it’s too early to tell how many companies will take advantage of the new NOL provision, Congress’s Joint Committee on Taxation estimates that the extension will accelerate some $33 billion worth of corporate tax refunds.

The ability to “recover cash taxes” will help companies — especially those in such hard-hit sectors as retail, real estate, and manufacturing — sustain business operations and make investments during uncertain economic times, contends Ernst & Young tax partner John McMahon. Credit Suisse, in a report released a week after the rule was issued, estimated that S&P 500 companies will be eligible to apply for an aggregate $5 billion in refunds related to taxes paid in 2008 alone. Seventy-seven companies in the S&P 500 reported a loss in 2008, nearly triple the number from the year before, according to an analysis by CFO (see “Loss Leaders,” below).

U.S. publicly held companies reporting NOLs

TARP Not Covered

The NOL carryback extension is part of the Worker, Homeownership, and Business Assistance Act of 2009, but temporarily extending the NOL carryback period to restock cash accounts is not a new concept. After 9/11, Congress granted a temporary five-year extension. In early 2009, it offered another five-year extension, but only for businesses with $15 million or less in sales.

Under the latest extension, companies of all sizes are permitted to carry back losses from either 2008 or 2009, but not both years. Small companies that benefited from the earlier extension can also take advantage of the new change, as long as they don’t use losses from the same year twice. (For example, if a small company has already applied NOLs from 2008 to a prior taxable year, only a loss from 2009 can be carried back under the new legislation.)

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