Detailed analysis of NOL carryback rules in the ''Worker, Homeownership, and Business Assistance Act of 2009''




Practitioners and businesses alike have hailed the NOL 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. This Practice Alert 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's 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's subject to the regular NOL carryback and carryover rules, except that it can't 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))

RIA observation: 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.
RIA observation: The Act doesn't 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))

RIA observation: 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))

RIA observation: 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.
RIA illustration 1: Taxpayer, a C corporation, an ESB, and a fiscal year taxpayer with a tax year beginning on Nov. 1 and ending Oct. 31, had an NOL of $400,000 for its tax year ending Oct. 31, 2008. Under pre-Act law, it elected to carry this NOL back to its 5th preceding tax year that ended Oct. 31, 2003. Taxpayer expects to have NOLs for both its 2009 and 2010 fiscal years. It may elect to carry either of those NOLs back to its 5th preceding tax year but cannot elect to carry both of them back since it already elected to carry its NOL for fiscal year 2008 back to the 5th preceding tax year.
RIA recommendation: 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.
RIA illustration 2: A calendar year C corporation that is not an ESB, has an NOL of $4 million for its 2008 tax year, and expects to have an NOL of $7 million for its 2009 tax year. It had taxable income of $2 million in 2003, $3 million in 2004, $4 million in 2005, $2 million in 2006 and $1 million in 2007. If it elects to carry its 2008 NOL back for more than 2 years, it will be able to offset its entire 2008 loss of $4 million but it will be only able to offset $1 million of its 2009 $7 million NOL by carrying it back to 2007. If it doesn't make the election for its 2008 tax year, it can offset $3 million of the 2008 NOL by carrying it back to 2006 and 2007 under the general rule. Then it will be able to offset $5.5 million of its 2009 NOL by carrying it back to 2004 (i.e., $1.5 million (50% of its 2004 taxable income of $3 million, see limit on carrying NOLs back to 5th preceding tax year, below), and all of its taxable income of $4 million in 2005. Thus, be electing to carry the 2009 NOL back to the 5th preceding tax year, it will be able to offset a total of $8.5 million of its combined NOLs for 2008 and 2009 instead of just $5 million that it would have been able to offset if it elected to carry back the 2008 NOL for 3 or more tax years.
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))

RIA illustration 3: ACE Corp., which is not an ESB, has an NOL of $5 million for its tax year ending Aug. 31, 2009. In its tax year ending Aug. 31, 2004, it had taxable income of $6 million. If Ace elects to carry its NOL back to its 2004 tax year, it will be able to apply only $3 million of that NOL against its taxable income for 2004. In determining the amount of the NOL that can be carried forward by Ace to years ending after Aug. 31, 2004, the NOL is reduced by only the $3 million that was used to offset taxable income for 2004. The balance of $2 million can be carried over to 2005, 2006, etc., until completely used up.
RIA observation: In deciding whether to elect to carry an NOL back 3, 4, or 5 tax years, taxpayers should determine which election will result in the largest tax refund. Thus, if the NOL is more than or at least equal to the taxpayer's combined income for the 3rd, 4th, and 5th years before the year in which it arose, then the loss should be carried back to the fifth year so that it can be used in all three years. On the other hand, if the NOL is less than the combined income for those three years, the taxpayer should try to carry it back to the year(s) in which income was taxed at the highest rate so as to get the highest refund, e.g., a year in which an individual is taxed at a 35% rate or a year in which a C corporation is taxed at a 38% “bubble” rate. In some cases, it may be better to not make the election because the largest tax savings will come from carrying the NOL back to the second year before the year in which the NOL arose. Generally, if the taxpayer can get at least some tax savings from a carryback to a year before the first year before the year in which the NOL arose, the taxpayer would not want to carry the NOL back to that year because the income for that first year could be applied against an NOL the taxpayer might have in its succeeding tax year. Unless the NOL rules are amended again, a taxpayer will have only one opportunity to carry an applicable NOL back to the 2nd, 3rd, 4th, or 5th years before the year in which the NOL arose.
RIA illustration 4: Taxpayer, a C corporation and a calendar year taxpayer that is not an ESB, expects to have an NOL of $20 million for its 2009 tax year. It had taxable income of $10 million in 2004, $5 million in 2005, $10 million in 2006, and $2.5 million in both 2007 and 2008. Taxpayer paid federal income taxes of $3.4 million on its 2004 income, $1.7 million on its 2005 income, $3.4 million on its 2006 income, and $850,000 on its income for both 2007 and 2008. If Taxpayer elects to carry its 2009 NOL back 5 years, the NOL will offset 50% of its income for 2004 ($5 million), and all of its income for 2005 and 2006 ($5 million + $5 million + $10 million = $20 million), and it will be entitled to a refund of $6,800,000 (the sum of 50% of the taxes it paid for 2004 ($1.7 million), and all of the taxes it paid for 2005 and 2006. If Taxpayer carries the NOL back only 4 years, it will completely offset its income for 2005, 2006, 2007, and 2008 ($5 million +$10 million + $2.5 million + $2.5 million = $20 million). This will also result in a refund of $6,800,000 (the sum of the taxes it paid for those four tax years) but it will mean that the income for 2008 will not be available to offset any NOL Taxpayer may possibly have in 2010 when Taxpayer will only be able to carry its NOL back for 2 years. Accordingly, Taxpayer should elect to carry its NOL back for 5 years so its taxable income for 2008 will be available to generate a refund if it has an NOL in 2010.
RIA illustration 5: Assume the same facts as in Illustration (4) except that in 2005, Taxpayer had taxable income of $15 million on which it paid federal income taxes of $5,150,000, and in 2006, it had taxable income of $18 million, on which it paid federal income taxes of $6,290,000. If Taxpayer elects to carry the NOL of $20 million back 5 years years, it will offset 50% of its income of 2004 ($5 million), and all of its income for 2006 ($15 million). This will result in a total refund of income taxes for those years of $6,850,000 (income taxes of $1.7 million for 2004, and $5,150,000 for 2005). However, if Taxpayer carries the NOL back only four years to 2005, it will be entitled to a refund of $6,990,000 ($5,150,000 for 2005 and $1,840,000 for 2006 when the top $3 million of its total income of $18 million was taxed at a bubble rate of 38%). Thus, by electing to carry back its NOL for only 4 years, Taxpayer's refund will be $140,000 higher than it would have been if it carried the refund back 5 years ($6,9990,000 − $6,850,000).
RIA illustration 6: Taxpayer, a C corporation and a calendar year corporation that is not an ESB, expects to have an NOL of $5 million for its 2009 tax year. It had taxable income of $6 million in 2004, $8 million in 2005, $10 million in 2006, $20 million in 2007, and $10 million in 2008. If it elects to carry back its NOL for either 5, 4, or 3 years it will get a refund of $1.7 million dollars because all the income it will offset in any of those tax years will be taxed at a rate of 34% (the rate that applies to a C corporation's taxable income over $335,000 and not over $10 million). On the other hand, if it does not make the election, it will get a refund of $1,850,000, the tax on a C corporation's taxable income over $15 million but not over $20 million). Thus, by not making the election, taxpayer will get a refund that is $150,000 higher than it would be if it did make the election ($1,850,000 − $1,700,000).
RIA observation: By not making the election in Illustration (6), Taxpayer is risking losing part of its taxable income for 2007 to offset an NOL for 2010 or a later year if the election to carry back an NOL for more than 2 years is extended to cover years beginning after 2009.
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))

RIA observation: 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.
RIA observation: The taxpayer must affirmatively elect the increased carryback. Absent any election, the regular NOL carryback period rules apply.
RIA recommendation: 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 won't 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))

RIA observation: 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