LeAnn Luna
LeAnn Luna
New NOL Rules Offer Benefits to Small Businesses

The recent stimulus bill provides that eligible small businesses can elect two-, three-, four- or five-year carryback periods for 2008 losses.

March 12, 2009
by LeAnn Luna

Under current rules, net operating losses (NOLs) can be carried back two years and forward 20 years, although exceptions exist for certain losses, such as individual losses for casualty and theft which can be carried back three years. The 2009 American Recovery and Reinvestment Act of 2009 (the Stimulus Act) amends IRC Sec. 172 to allow eligible small businesses to effectively elect a two-, three-, four- or five-year carryback period for 2008 losses.

The new rules potentially provide immediate cash to businesses suffering losses and increasingly unable to obtain operating loans. Increased carryback periods also effectively smooth taxable income over a period of years and eliminate arbitrary peaks and valleys that would occur with no, or shorter, loss carryback time limits. The Tax Policy Center gives the NOL provision a "C" grade. Although the effects are expected to be minor, funds from NOL carrybacks could stimulate some investment. The effectiveness of the depreciation incentives in the Act might also be more effective since operating losses generated from faster write-offs of equipment purchases may be usable immediately.

Eligible Small Business

In general, eligible taxpayers are corporations, partnerships or sole proprietorships that have average annual gross receipts for the period 2006 to 2008 of $15 million or less. Related businesses must be aggregated for the gross receipts test (see Sections 448(c) and 172(b)(1)).

Selecting the Carryback Period

Taxpayers reporting a loss on their 2008 return (defined below) can elect select the two-, three-, four- or five-year carryback period that maximizes their refund. Taxpayers whose 2008 losses exceed the total taxable income for the previous five-year period will often elect the five-year carryback period. Other taxpayers should begin the analysis by calculating the total refund using each of the available periods. The goal is to apply losses to years with the highest marginal tax rates, and minimize losses applied to low tax years. Tax preparers should consider the possibility of additional losses in 2009. Although President Obama's recent budget proposal includes a provision to permanently expand the NOL loss carryback, as of this writing, 2009 losses will only be allowed a carryback of two years.

Example: An eligible small business incurs a $400,000 loss in 2008 and presents the following taxable income and (tax paid) history:

2003 $75,000 ($13,750)
2004 $75,000 ($13,750)
2005 $250,000 ($80,750)
2006 $0 ($0)
2007 $150,000 ($41,750)

Electing a five-year carryback to 2003 wipes out the income from 2003 to 2005 and saves $108,250 in taxes, but electing a three-year carryback to 2005 saves $122,500 in taxes, an advantage of $14,250. However, assume that the taxpayer expects an additional loss of at least $100,000 in 2009. If the taxpayer had elected the three-year carryback period, the entire 2009 loss can only be carried forward since income for 2005 and 2007 was eliminated with the 2008 loss carryback, and the carryback period for 2009 losses reverts back to two years. If taxpayer had elected the five-year carryback period, the 2009 losses could offset $100,000 of 2007 income resulting in tax savings attributable to the 2009 loss of $34,250. After considering the 2009 losses, the total tax savings from electing the five-year carryback is 142,500, a $20,000 advantage over the three-year carryback election.

Applicable 2008 NOL

The expanded carryback options apply only to "2008" losses. For calendar year taxpayers, the applicable year is 2008. For taxpayers with a fiscal year, the default year is the year ending in 2008. However, taxpayers can alternatively elect to apply the special rules to years beginning in 2008 (the rules apply to only one tax year). Therefore the special rules can apply to any fiscal year ending between January 2008 and November 2009.

Election Required

The default carryback period is still two years. Taxpayers must positively elect to use one of the alternative periods no later than the due date for their 2008 return, including extensions. Calendar-year individuals who file on time must make the election by April 2009, although they can of course extend their 2008 return if more time is needed to determine the optimum carryback strategy. The election is irrevocable once made.

Since many taxpayers have already filed their returns for fiscal years ending in 2008, special rules allow for the carryback special election to be made any time on or before April 2009 (60 days after the date the bill was finalized). This special time limit presumably applies to calendar-year corporations that would otherwise have to make the election by the March 2009 due date of their return.

Time Period for Filing Refund Claim

Claims for refund must be generally filed within 12 months after the end of the year in which the loss arose. Claims for refund due to losses for a fiscal year ended in June 2008 must be filed by June 2009, for example. However, the rules extend the refund claim deadline for tax years ending before April 3008 to April 2009. For example, the 12-month filing deadline for a taxpayer with a year-end of January 2008 has already passed. Under the transitional rule, the taxpayer would have until April 2009 to file a quick refund claim.

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LeAnn Luna is an Associate Professor of Accounting and holds a dual appointment with the Department of Accounting and Information Management and the Center for Business and Economic Research, both at The University of Tennessee.