Expanded Loss Carryback Rules Create Tax Planning Opportunities

November 25, 2009

On Nov. 20, 2009, the IRS issued guidance on a new law that expands the ability of most business taxpayers to carry back net operating losses (NOLs) and obtain tax refunds.

Under prior law, business taxpayers were generally permitted to carry back NOLs to the prior two taxable years. The recently enacted Worker, Homeownership, and Business Assistance Act of 2009 expands the carryback period, but only for NOLs that arise in taxable years ending after Dec. 31, 2007 and beginning before Jan. 1, 2010 (hereafter referred to as 2008 or 2009 taxable years). More specifically, the act permits taxpayers to carry back 2008 or 2009 NOLs for two years (as permitted under prior law), or to expand the NOL carryback period to three, four or five years. This change is significant because it enables many companies to increase liquidity by obtaining a refund of previously paid taxes.

Similar legislation enacted earlier this year applied only to small businesses. The expanded provision applies to all taxpayers with business losses other than those that received payments under the Troubled Asset Relief Program. Generally, similar relief is provided for losses from operations of life insurance companies. The election to carry back NOLs for three, four or five years is irrevocable and, except for small businesses that made a previous election, may be made only for a single taxable year. In addition, NOLs carried back five years may offset no more than 50% of a taxpayer’s taxable income in the fifth preceding year. No such limitation applies to the third or fourth preceding year.

The IRS guidance prescribes when and how to make the expanded carryback election for (i) taxpayers that have not claimed a deduction for an NOL arising in a taxable year ending in 2008 or 2009; (ii) small businesses that made a previous election; and (iii) taxpayers who previously filed an election to forego the NOL carryback period. Generally, elections must be made on or before the due date (including extensions) for filing the return for the taxpayer’s last taxable year beginning in 2009.

The election is available for an affiliated group of corporations that files consolidated tax returns, with the election being made by the common parent. Although the new law is beneficial to many companies, it could in certain instances adversely affect purchasers who acquire a subsidiary corporation from a selling group. When a subsidiary leaves the group, it takes with it an allocable portion of the consolidated NOL. This tax attribute often benefits the purchaser by reducing the amount of tax payable in the future by the purchased subsidiary. However, the specific amount of NOL retained by the sold subsidiary is determined after NOL carrybacks. As a result, the selling group apparently could elect under the new law to carry back a larger amount of the pre-sale NOLs, thereby reducing or eliminating the NOLs available to be retained by the sold subsidiary. This could adversely impact the purchaser by unexpectedly increasing the post-sale tax liability of the subsidiary.

The expanded carryback provisions present taxpayers that have NOLs for taxable years ending in 2008 and/or 2009, with substantial planning opportunities – and difficult decisions. With a choice of two (and, in the case of non-calendar year taxpayers, three) taxable years from which to carry back NOLs, and a choice of three additional taxable years to which to carry back NOLs, detailed analysis will be required to determine the optimal election.

Furthermore, it may be possible (subject to an anti-abuse rule contained in the new legislation) to accelerate losses or deductions, or to defer income to increase or generate a 2009 NOL. In addition to the possibility of selling assets with built-in losses before year-end, various techniques such as those involving tax accounting methods may be employed to augment or generate 2009 NOLs that may be carried back to generate refunds.