By Michael L. Green
The rough economy has caused many businesses to operate at a loss, also termed a net operating loss (NOL). As you would expect, an NOL occurs when there is an excess of business deductions (computed with certain modifications) over gross income in a particular tax year. The good news is there generally are no federal taxes due, and the current-year NOL can be deducted through NOL carryback or carryover in another tax year in which gross income exceeds business deductions (a profitable year). 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’s allowable, and is then carried to the next earliest tax year. Carrying back an NOL allows a taxpayer to recover taxes paid in a prior period and improve business cash flow. A taxpayer may elect to forgo the entire NOL carryback period and instead carry it forward if it is more beneficial to do so.
For NOLs arising in tax years ending after December 31, 2007, small businesses can elect to increase the carryback period for an applicable 2008 NOL from two years up to five years. A small business for this purpose is defined as a corporation, partnership, or sole proprietorship whose average annual gross receipts for the three-tax-year period ending with the tax year in which the loss arose are $15 million or less.
The recent Worker, Homeownership, and Business Assistance Act of 2009 (Act) provides an election for even more taxpayers (not just small businesses) to increase the carryback period for an applicable NOL to three, four, or five years. For this provision, an applicable NOL means the taxpayer’s NOL for any tax year ending after December 31, 2007, and beginning before January 1, 2010. Generally, an election may be made only once. However, an eligible small business that elected an NOL carryback before November 6, 2009 (the enactment date), may make a second election in a subsequent tax year that begins before January 1, 2010.
The Act limits the amount of the NOL that can be carried back to the fifth tax year preceding the loss year to no more than 50% of the taxpayer’s taxable income for that fifth preceding tax year. The amount of the NOL otherwise carried to tax years after the fifth preceding tax year is adjusted to take into account that the NOL could offset only 50% of the taxable income for that fifth preceding tax year.
Example: Five-year NOL Carryback. Justa Corporation (Justa), a taxpayer averaging $200 million in annual sales, incurs a $5 million NOL during its year ending August 31, 2009. During its tax year ending August 31, 2004, it had taxable income of $6 million. If Justa carries its NOL back to the 2004 tax year, it will only be able to apply $3 million of that 2009 loss against its taxable income in 2004 (because of the 50% limitation). The remaining $2 million can be used to offset taxable income in years 2005 or later. By carrying the 2009 NOL back to prior profitable years, Justa can recover taxes paid in those years, increase its cash flow, and use the proceeds to meet payroll requirements, pay operating expenses, or purchase necessary equipment.
Dealing with business losses can be a painful experience, but NOL treatment and the subsequent recovery of taxes previously paid can often substantially improve this trying situation. However, the tax treatment of NOLs is quite technical, so please contact us to discuss how you might benefit from this provision.
Michael L. Green Tax and Financial, is located in the Valencia Industrial Center in Valencia and can be reached by calling (661) 257-4111.