NOL CARRYBACK RULES IN THE "WORKER, HOMEOWNERSHIP, AND BUSINESS ASSISTANCE ACT OF 2009"

Practitioners and businesses alike have hailed the NOL (Net Operating Loss) changes in the ''Worker, Homeownership, and Business Assistance Act of 2009'' (the Act), signed into law on Nov. 6 as P.L. 111-92. These changes extend the 5-year carryback of NOLs to apply to 2009 NOLs, and expand the 5-year carryback's availability to include most businesses (not just Eligible Small Businesses, or ESBs). But the rules are tricky, including a new 50% limit on the NOL that can be carried back to the 5th preceding tax year, and a complex transition rule. ThisArticle carries a detailed analysis of the new NOL carryback rules in the Act, including numerous examples illustrating the rules' practical impact, and strategies for businesses large and small.

Five-Year Carryback of NOLs Extended to Include 2009 NOLs and to Apply to Most Businesses

A Net Operating Loss (NOL) is the excess of business deductions (computed with certain modifications) over gross income in a particular tax year. The loss can be deducted, through an NOL carryback or carryover, in another tax year in which gross income exceeds business deductions. In general, NOLs may be carried back two years and forward 20 years. The NOL is first carried back to the earliest tax year for which it is allowable as a carryback or a carryover, and is then carried to the next earliest tax year. A taxpayer may elect to forego the entire carryback period for an NOL and instead carry it forward. Life insurance companies may carry back losses for three years.

If a corporation has a Corporate Equity Reduction Transaction (a CERT, i.e., a major stock acquisition or an excess distribution) and an "excess interest loss" (i.e., interest allocable to the CERT) for a "loss limitation year," the loss is an NOL. It is subject to the regular NOL carryback and carryover rules, except that it cannot be carried back to a tax year before the year in which the CERT occurred. The "loss limitation year" is generally the tax year in which the CERT occurred (the "CERT year") and each of the next two tax years.

For purposes of the alternative minimum tax (AMT), a taxpayer's NOL deduction cannot reduce the taxpayer's alternative minimum taxable income (AMTI) by more than 90% of the AMTI.

For NOLs arising in tax years ending after Dec. 31, 2007, ESBs can elect to increase the NOL carryback period for an applicable 2008 NOL (the "applicable NOL") from 2 years to 3, 4, or 5 years. An ESB is a corporation or partnership that meets the gross receipts test of Code Sec. 448(c) ) (applied by substituting $15 million for $5 million) for the tax year in which the loss arose, or a sole proprietorship that would meet that test if the proprietorship were a corporation. This means an ESB is any trade or business (including one conducted in or through a corporation, partnership, or sole proprietorship) whose average annual gross receipts (for the three-tax-year period (or shorter period of existence)) ending with the tax year in which the loss arose are $15 million or less.

An applicable 2008 NOL is the taxpayer's NOL for any tax year ending in 2008, or, at the taxpayer's election, any tax year beginning in 2008. Any such election is irrevocable. Additionally, any carryback election may be made only with respect to one tax year. If an ESB makes an election to increase the carryback period for an applicable 2008 NOL, then Code Sec. 172(b)(1)(E)(ii) (which defines "loss limitation year") is applied by using the whole number that is one less than the number of years the taxpayer elected as the carryback for the NOL instead of "two."

New law. The Act provides an election for most taxpayers (not just small businesses) to increase the carryback period for an applicable NOL to 3, 4, or 5 years from 2 years. (Code Sec. 172(b)(1)(H)(i)(I), as amended by Act Sec. 13(a))

Thus, a business may elect to carry an applicable NOL back to the 3rd, 4th, or 5th preceding tax year instead of just to the 2nd preceding tax year. If an election is made to carry an NOL back for 5 years, any part of the NOL that does not offset taxable income in that 5th preceding tax year (subject to the 50% limit, see below) will be carried over to the 4th preceding tax year, etc. If the election is made to carry the NOL back only 4 years, then any part of the NOL that does not offset taxable income in that 4th preceding tax year will be carried over to the 3rd preceding tax year, etc.

The Act does not change the allowable carryforward period for NOLs.

Applicable NOL defined. An applicable NOL means the taxpayer's NOL for any tax year ending after Dec. 31, 2007, and beginning before Jan. 1, 2010. ( Code Sec. 172(b)(1)(H)(ii) , as amended by Act Sec. 13(a))

This means that an applicable NOL for a tax year that is a 2008 or 2009 calendar year or a fiscal year that begins in 2007, 2008, or 2009 can be carried back to the 3rd, 4th, or 5th preceding tax year, subject to the only one election rule (see below).

One election rule. Generally, an election may be made for only one tax year. (Code Sec. 172(b)(1)(H)(iii)(I), as amended by Act Sec. 13(a)) However, an ESB that made or makes an election under the Code as in effect before Nov. 6, 2009 (the enactment date) may make an election for 2 tax years instead of just 1. (Code Sec. 172(b)(1)(H)(v)(I), as amended by Act Sec. 13(a))

This means that if an ESB elects to carry a 2008 NOL back to the 3rd, 4th or 5th preceding tax year under the provisions of pre-Act law, it can also elect, under the Act, to carry an NOL for a second tax year back to the 3rd, 4th, or 5th preceding tax year as well. If the election is made for a 2008 calendar year, it can also be made for the 2009 calendar year. If it was made for a fiscal year beginning in 2007 and ending in 2008, it can also be made for (1) a fiscal year beginning in 2008 and ending in 2009, or (2) a fiscal year beginning in 2009 and ending in 2010 (but not for both); see definition of applicable NOL, below.

A taxpayer with more than one NOL that is eligible to be carried back for 3, 4, or 5 years should determine where the greatest tax savings will result. Remember that the year that is not elected can be carried back only two years. The size of the NOL in each year will usually be the determining factor. The larger the NOL, the more likely it will be that the taxpayer will want to carry it back as far as possible especially if the taxpayer needs to use taxable income from more than two years to completely use up the NOL.

Limit on amount of NOL that can be carried back to 5th preceding tax year. The amount of the NOL that can be carried back to the 5th tax year before the loss year may not be more than 50% of the taxpayer's taxable income for that 5th preceding tax year determined without taking into account any NOL for the loss year or for any tax year after the loss year. (Code Sec. 172(b)(1)(H)(iv)(I), as amended by Act Sec. 13(a)) The amount of the NOL otherwise carried to tax years after the 5th preceding tax year is adjusted to take into account that the NOL could offset only 50% of the taxable income for that 5th preceding tax year. (Code Sec. 172(b)(1)(H)(iv)(II), as amended by Act Sec. 3(a))

The 50% limitation does not apply to the applicable 2008 NOL of an ESB with respect to which an election is made under pre-Act law even if the election is made after Nov. 6, 2009, the date of enactment of the Act. (Code Sec. 172(b)(1)(H)(iv)(III) , as amended by Act Sec. 13(a))

How to make the extended carryback election. The extended carryback election under the Act must be made in such manner as IRS determines, and must be made by the due date (including extensions) for filing the taxpayer's last tax return for a tax year beginning in 2009. (Code Sec. 172(b)(1)(H)(iii)(II), as amended by Act Sec. 13(a))

Thus, the election can be made for a tax year beginning before 2009 as long as it is made by the due date (including extensions) for filing the taxpayer's last tax return for a year beginning in 2009.

The taxpayer must affirmatively elect the increased carryback. Absent any election, the regular NOL carryback period rules apply.

The taxpayer should use the tentative (or "quick") carryback procedures to expedite the recovery of the refund. Under these procedures, taxpayers can recover a refund attributable to an NOL carryback before IRS processes the return filed for the year the NOL arises. By using them, the taxpayer will not have to wait until IRS processes the return for the NOL year to get the refund. Presumably, as was the case for ESBs with respect an applicable 2008 NOL, a taxpayer will be able to make the election on the applicable claim form (Form 1045 for individuals and Form 1139 for corporations).

Irrevocability of election. Once made, the extended carryback election is irrevocable. (Code Sec. 172(b)(1)(H)(iii)(II), as amended by Act Sec. 13(a))

Determining "loss limitation year" if extended carryback period is elected. As was the case for ESBs, if a business makes an election to increase the carryback period for an applicable NOL, then Code Sec. 172(b)(1)(E)(ii) (which defines "loss limitation year" with respect to a CERT) is applied by using the whole number that is one less than the number of years the taxpayer elected as the carryback for the NOL instead of "2." (Code Sec. 172(b)(1)(H)(i)(II), as amended by Act Sec. 13(a))

Suspension of 90% Limitation on NOL for AMT purposes
For tax years ending after 2002, the Act suspends the 90% limitation on the use of any alternative tax NOL deduction attributable to the carryback of an applicable NOL for which the extended carryback period is elected. (Code Sec. 56(d)(1)(A)(ii)(I), as amended by Act Sec. 13(b))

Increase in Carryback Period for Life Insurance Companies
For losses from operations arising in tax years ending after Dec. 31, 2007, the Act allows life insurance companies to elect to carry back an applicable loss from operations for 4 or 5 years and not just 3 years as is provided under pre-Act law. (Code Sec. 810(b)(4)(A), as amended by Act Sec. 13(c)) An applicable loss from operations is the life insurance company's loss from operations for any tax year ending after 2007 and beginning before 2010. (Code Sec. 810(b)(4)(B), as amended by Act Sec. 13(c)) The amount of the loss that can be carried back to the 5th preceding tax year is limited to 50% of the taxable income for such preceding tax year. (Code Sec. 810(b)(4)(D), as amended by Act Sec. 13(c))

Transition Rules for NOLs
Under transition rules, a taxpayer may revoke any election to waive the carryback period under either Code Sec. 172(b)(3) or Code Sec. 810(b)(3) with respect to an applicable NOL or an applicable loss from operations for a tax year ending before Nov. 6, 2009, by the extended due date for filing the tax return for the taxpayer's last tax year beginning in 2009. Similarly, any application for a tentative carryback adjustment under Code Sec. 6411(a) with respect to such loss is treated as timely filed if filed by the extended due date for filing the tax return for the taxpayer's last tax year beginning in 2009. (Act Sec. 13(e)(4))

Normally, an election to waive the carryback period under Code Sec. 172(b)(3) or Code Sec. 810(b)(3) so that the loss will be carried forward cannot be revoked. The transition rules afford an opportunity to undo the waiver with respect to an applicable NOL or an applicable loss from operations for a tax year ending before Nov. 6, 2009. They provide ample time to do this as the taxpayer has until the extended due date of its last tax year beginning in 2009 to make the election. By then, the taxpayer should be in a good position to determine whether to go ahead with the revocation and take advantage of the longer carryback period under the new law.

Businesses Ineligible to Elect Extended Carryback Period
The right to elect an extended carryback period under the Act does not apply to any taxpayer if:

• the Federal government acquired an equity interest in that taxpayer under the Emergency Economic Stabilization Act of 2008. (Act Sec. 13(f)(1)(A))
• the Federal government acquired before Nov. 6, 2009, any warrant (or other right) to acquire any equity interest with respect to the taxpayer under the Emergency Economic Stabilization Act of 2008. (Act Sec. 13(f)(1)(B))
• the taxpayer receives after Nov. 6, 2009, funds from the Federal government in exchange for an interest described above under a program established under title I of Division A of the Emergency Economic Stabilization Act of 2008 (unless such taxpayer is a financial institution as defined in Section 3 of such Emergency Economic Stabilization Act, and the funds are received under a program established by the Secretary of the Treasury for the stated purpose of increasing the availability of credit to small businesses using funding made available under that Act). (Act Sec. 13(f)(1)(C))

The right to elect an extended carryback period also does not apply to any taxpayer that at any time in 2008 or 2009 was or is a member of the same affiliated group (as defined in Code Sec. 1504 , determined without regard to Code Sec. 1504(b)) as a taxpayer listed above. (Act Sec. 13(f)(3))

I hope this information is helpful.

Please contact the Law Offices of William H. Copperthwaite Jr., L.L.C. if you have any questions.

Please note that the information contained in this summary is intended for informational purposes only and is not to be considered tax/legal advice. For specific advice, please contact the Law Offices of William H. Copperthwaite Jr., L.L.C.