New Law - NOL Carrybacks

Legislation enacted on November 6, 2009 (H.R. 3548, the Worker, Homeownership, and Business Assistance Act of 2009 (the “Act”) significantly enhances the net operating loss (“NOL”) carryback provisions to include an elective, longer carryback period for nearly all individual and corporate taxpayers.

The American Recovery and Reinvestment Act (the so-called Stimulus Bill) enacted earlier this year had also included a temporary measure to allow certain small businesses (i.e., those with average gross receipts of less than $15 million), to elect a longer carryback period, but denied relief to many individuals and to larger corporate taxpayers. As explained later, the Act creates significant opportunities for many more taxpayers to obtain immediate cash refunds from NOLs generated in taxable years beginning after December 31, 2007 and before January 1, 2010 (i.e., NOLs generated in 2008 or 2009 for calendar year taxpayers). The IRS issued Revenue Procedure 2009-52 on November 20, 2009 providing detailed guidance on how to elect a longer carryback period.

Key NOL Provisions of the Act

The key provisions of the Act concerning net operating losses may be summarized as follows:

  1. Taxpayers may elect (the “Election”) to increase the general two-year NOL carryback period for losses generated in taxable years beginning after December 31, 2007, and before January 1, 2010 to a three-, four-, or five-year carryback period. Except as noted later in Item 3, only one Election may be made (i.e., a calendar-year taxpayer generating an NOL in 2008 and 2009 may elect a longer carryback period for either 2008, or for 2009). If a five-year carryback period is elected, only 50 percent of the taxable income in that fifth prior year may be offset by the loss carried back from 2008 or 2009. Any remaining NOL is available for carryover to subsequent years. Thus, for example, if a calendar year taxpayer incurred a $1,000,000 NOL in 2008, an Election can be made to carryback that NOL to 2003. If taxable income in 2003 was $500,000, only $250,000 of the 2008 NOL could be used to offset 2003 income. The balance of the NOL from 2008 ($750,000) remains as a carryover to 2004 and later years. Note: This limitation does not apply to a small-business taxpayer that elected (or elects) the five-year carryback period for a 2008 NOL under the provisions of the Stimulus Bill.
  2. As explained in detail in Revenue Procedure 2009-52, the Election must be made by the date, including extensions, of the taxpayer’s return for its year beginning in 2009, and can file a refund in the form of a tentative carryback adjustment or a claim for refund. Thus, taxpayers need not decide before all information is available how best to maximize the benefit of this new provision. A taxpayer who has already filed its return showing an NOL for its year beginning in 2008 can elect a longer carryback period via an amended return even if it has already filed a carryback claim for the 2008 NOL. In addition, a taxpayer who elected to forego the carryback period for a 2008 loss, for example, because that was more advantageous than a two-year carryback, may revoke that election anytime before the due date, including extensions, of the taxpayer’s return for its year beginning in 2009.
  3. A small-business taxpayer that elected a longer NOL carryback period under the provisions of the Stimulus Bill for a 2008 NOL, may also make the Election under the Act for a 2009 NOL, and is not limited to electing a longer carryback period in only one year. It would, however, be subject to the 50-percent limitation noted earlier on offsetting income in the fifth taxable year preceding the 2009 loss year.
  4. Taxpayers that have previously undergone a so-called corporate equity reduction transaction (“CERT”), incurred a significant additional level of indebtedness (e.g., in a leveraged buyout transaction) and have a significant interest expense component as part of an NOL, are subject to special rules and limitations under the normal NOL carryback rules for a defined CERT application period. A special rule extends the application period for CERT interest deductions for taxpayers making the Election. Interest deductions attributed to the CERT cannot be carried back as part of the NOL to a tax year preceding the year of the CERT.
  5. Taxpayers making an Election are not eligible to use the special three-year carryback period for the portion of the NOL due to certain casualty and thefts, losses for certain taxpayers in federal disaster areas, and certain farming losses.
  6. The 90 percent limitation on use of any alternative minimum tax (“AMT”) NOL is suspended for any NOL to which the Election applies.
  7. A modified version of the Election applies to life insurance companies. Additionally, taxpayers who received so-called TARP funds under the Emergency Economic Stabilization Act of 2008 are not eligible to make the Election.

Opportunities Under the Act

The election to extend the loss carryback period for up to five years for a 2008 or 2009 NOL creates opportunities to reach incremental taxable income in prior profitable taxable years and thus generate significant cash refunds. Taxpayers with a complex tax attribute profile (e.g., taxpayers with significant business tax credits, foreign tax credits, or AMT credits) may need to undertake multi-year analyses to determine (a) whether the Election for a 2008 or 2009 NOL year should be made (if there is an NOL in both years), and/or (b) whether the Election should be of a three-, four-, or five-year carryback period. In addition, taxpayers generating NOLs during the 2008 or 2009 years whose component parts are treated under one of the other special NOL categories (e.g., taxpayers with so-called specified liability losses), will also need to undertake a multi-level analysis to optimize their tax refunds in combination with the Election.

Taxpayers filing consolidated income tax returns that have been involved in merger and acquisition activity in prior years may need to review applicable purchase and sale agreements (“Agreement”) to determine the contractual implications (i.e., which party is entitled to the refund attributable to an NOL carryback) of making the Election. For example, if a subsidiary in the consolidated group was acquired from another consolidated group during the five-year period before generating an NOL in 2008 or 2009, the subsidiary’s share of any consolidated NOL may have to be carried to the prior group’s consolidated income tax return, with any related refund being potentially for the account of the prior consolidated group, depending on the terms of the Agreement. Revenue Procedure 2009-52 indicates that pending further guidance, a consolidated group cannot make or revoke a so-called “split” waiver of the NOL carryback period under the consolidated return regulations for a subsidiary acquired by the group.

The Election should be available to individual taxpayers that generate an NOL in 2008 or 2009, calculated with the existing required statutory adjustments applicable to individual taxpayers. Moreover, the Election should also be available to foreign corporations with income effectively connected to a trade or business within the United States that file Form 1120 F and generate an NOL in 2008 or 2009.

Tax Planning Under the Act

Before making an irrevocable Election to carry back an NOL to 2003, or later, taxpayers should consider the entire impact of such an election. Failure to analyze all the implications of the Election could result in unexpected and unpleasant surprises. For instance, multinational companies that elect to take advantage of the extended NOL carryback provision must consider the effect this could have on their foreign tax credits (FTCs) taking into account the changes made to the credit carryback/carryover rules starting in 2005. Companies also need to determine the impact on financial statements, financial statement disclosures and potential adjustments to valuation allowances.

Taxpayers should consider taking traditional tax planning steps to maximize an NOL eligible for the Election. For example, planning to accelerate deductions/defer income, accounting method elections or changes, bonus depreciation, other beneficial elections (e.g. the Stimulus Bill election to defer certain cancellation of indebtedness income), should be considered to maximize opportunities to benefit from the Election. Additionally, taxpayers should be alert to, and clearly analyze whether and to what extent, the various states adopt the provisions of the Act for income tax purposes (e.g., New York is reportedly following the Election; California is not).

It is important to note that Congress, having previously identified tax-planning signals developing in the marketplace in or around the passage of the Stimulus Bill, has specifically given “anti-abuse” authority to the Treasury to prescribe regulations that will serve to chill tax planning under the Election that is perceived as overly-aggressive. This authority specifically includes identifying “anti-stuffing” rules and “anti-churning” rules. In particular, the “anti-churning” rules are targeted toward certain sale-leaseback transactions, where, for example, an asset with a built-in economic loss (thus, potentially increasing an applicable NOL) is sold to a third party, and leased back to the taxpayer. Presumably, some guidance in this area is forthcoming from Treasury.