Federal tax law provides that in general net operating losses (NOLs) can be carried back two years to obtain refunds against taxes paid. On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 1 (ARRA), which provided a five-year NOL carryback provision for eligible small business taxpayers with gross receipts averaging $15 million or less over a three-year period.
On November 6, 2009, the president signed into law the Worker, Homeownership, and Business Assistance Act of 2009 2 (WHBAA), which provided an NOL carryback provision for up to five years for NOLs incurred in tax years beginning or ending in either 2008 or 2009 (but not both). 3 This provision provided the following:
- It applies to all taxpayers (except for those who receive federal assistance from the Troubled Asset Relief Program) and is not limited to eligible small businesses;
- If a taxpayer makes the election to carry back an NOL to the fifth preceding year, the NOL carryback is limited to 50% of the taxable income in the fifth preceding year. 4 The remaining NOL balance can be carried forward to the fourth preceding year, and so on until the loss is used or expired;
- It suspends the 90% limitation, effective for tax years ending after December 31, 2002, on the use of any alternative tax NOL attributable to carrybacks of the applicable NOL for which an extended carryback period is elected;
- Eligible small businesses that have already elected to carry back 2008 losses under ARRA are permitted to carry back losses from 2009 under WHBAA (for a noneligible small business, an election may be made for only one tax year); and
- A taxpayer must make the election by the extended due date for filing the return for the taxpayer’s last tax year beginning in 2009 (the election, once made, is irrevocable). 5
On November 20, 2009, the IRS provided guidance on the new provision by issuing Rev. Proc. 2009-52, 6 which prescribed when and how to make an election under Sec. 172(b)(1)(H) for (1) taxpayers that have not claimed a deduction for an applicable NOL; (2) taxpayers that previously claimed a deduction for an applicable NOL; and (3) taxpayers that previously filed an election to forgo the NOL carryback period.
Federal Tax Implications
Impact on Sec. 199 Domestic Production Activities Deduction
Sec. 199 was enacted in the American Jobs Creation Act of 2004. 7 It allows a domestic production activities deduction equal to 3% for years beginning in 2005 or 2006, 6% for years beginning in 2007, 2008, or 2009, and 9% in subsequent years of the lesser of taxable income or qualifying production activities income. 8 Thus, when deciding whether to carry back the NOLs, a company should consider the detriment of permanently losing the Sec. 199 deduction for the carryback years because of reductions in income as well as the possibility of the Sec. 199 deduction’s being repealed or limited in future years. 9
Sec. 382 Limitation
Sec. 382 applies to a loss corporation, which is a corporation with either a current-year NOL, an NOL carryover, or an overall built-in loss. When there is an ownership change, a loss corporation’s ability to use its tax attributes (e.g., NOLs or tax credits) is restricted by the Sec. 382 limitation. The three-year testing period begins on the first day of the tax year in which the corporation first becomes a loss corporation. An NOL carryback claim may generate a loss corporation for Sec. 382 purposes retroactively back to that year, which may affect the timing of an ownership change due to the expanded testing period.
A corporation will also need to consider whether, at the time of the ownership change, the corporation has net unrealized built-in loss in its assets. The built-in loss recognized during a five-year period following the ownership change is treated as if it had been generated prior to the ownership change and is part of the pre-change NOL. To the extent the recognized built-in loss exceeds the Sec. 382 limitation, it cannot be carried back.
Separate Return Limitation Year
When a new member of a consolidated group generates an NOL that contributes to a consolidated NOL, the new member may carry back the NOL to its profitable separate return years or its profitable former consolidated group. If the member’s cumulative contribution to the former consolidated group’s taxable income is a loss, its NOL cannot be carried back to its former group unless the application of the separate return limitation year subgroup rules allows the NOL to be carried back.
A corporation that considers filing the NOL carryback claim may also need to review the new member’s purchase agreement and determine whether there is a carryback waiver election for the consolidated NOL attributable to a new member, how a refund claim is to be processed, and who is entitled to the cash refund.
A corporate equity reduction transaction (CERT) is a debt finance transaction that is either a major stock acquisition or an excess distribution. 10 A corporation’s ability to carry back certain NOLs generated in the year of a CERT or in the two years succeeding a year before the CERT is limited. If a CERT exists, the taxpayer cannot carry back to a pre-CERT year the portion of the NOL that is attributable to the enhanced interest deduction, but can carry it forward. All a corporation’s interest deductions are taken into consideration for purposes of the CERT limitation, not just the interest deduction that is related to the CERT.
A special rule applies to taxpayers that elect to use an extended carryback period for applicable NOLs from 2008 or 2009. If a taxpayer makes the election for an applicable NOL, the loss limitation year is the tax year in which the CERT occurred and each of the succeeding tax years, the number of which is one less than the number of years that the taxpayer elected as the extended carryback period. 11
The alternative minimum tax (AMT) is a tax system parallel to the regular tax system. In general, the AMT NOL is the regular tax NOL as modified by the adjustments required under Secs. 56 and 58 and tax preference items under Sec. 57. Use of an AMT NOL is limited to 90% of alternative minimum taxable income in the carryover or carryback years. 12
The new law suspends the 90% limitation on the use of any AMT NOL for the extended carryback period. 13 Therefore, when a company carries back the AMT NOL to the extended carryback period, the new law allows an AMT NOL to fully offset alternative minimum taxable income in the carryback year. If a company paid the AMT during any part of the extended carryback period, it will be able to make an election to recoup the AMT. In applying the 50% of taxable income limitation with respect to the carryback of an alternative tax NOL deduction to the fifth preceding tax year, the limitation is applied separately based on alternative minimum taxable income.
Income Tax Accounting Implications
Corporate taxpayers should be aware of how the extended NOL carryback will affect their financial statements. Accounting Standards Codification (ASC) Topic 740 (formerly FAS 109), Income Taxes, requires a valuation allowance if it is more likely than not that all, or a portion, of a deferred tax asset will not be realized based upon the weight of the available evidence, both positive and negative. ASC 740 provides four possible sources of taxable income to realize a tax benefit and determine the need for a valuation allowance, including taxable income in prior carryback years if an NOL carryback is permitted under the tax law. A taxpayer must consider an adjustment to an existing valuation allowance because the new law increases the number of carryback years and potentially increases the amount of taxable income available to realize deferred tax assets. Therefore, all or a portion of the valuation allowance may no longer be necessary.
ASC 740 also requires that any adjustment to the current tax payable/refundable and deferred tax assets/liabilities (including related valuation allowance) for the effect of a change in tax law is recognized in the period that includes the enactment date. Thus, because the Worker, Homeownership, and Business Assistance Act was enacted November 6, 2009, a calendar-year company should recognize any adjustments due to the tax law changes in the act in its fourth quarter, with spreading to earlier or later quarters prohibited.
For purposes of ASC 740-10 (formerly FIN 48), an NOL carryback to tax years where the statute of limitation is closed for assessment and refund will not extend the statute of limitation but will allow the IRS to reexamine all the tax issues, including new Tier I issues in the carryback year, and to determine the adjustment to the tax attributes or the refund claim. Thus, the company needs to reevaluate all the tax positions for the carryback year as if they were tax positions for the open tax years.
International Tax Implications
A company that elects to carry back a 2008 or 2009 NOL to tax years 2003, 2004, 2005, or 2006 may reduce its foreign tax credit (FTC) limitation in that year because U.S. source loss may be allocated to reduce foreign-source income. This may generate excess foreign tax credits, which the company can carry forward. The carryforward period for foreign tax credits is shorter than for federal NOLs. 14 Thus, a multinational company should consider its ability to use the “freed-up” FTCs in years subsequent to the carryback years and the expiration date of the FTCs.
A company’s future use of the FTCs may also be affected by the carryback as a result of the potential recapture of overall foreign loss accounts, separate limitation loss accounts, and overall domestic loss accounts resulting from the NOL utilization.
Sec. 965 Repatriation Provision
The Sec. 965 repatriation provision was included in the American Jobs Creation Act of 2004. It created a one-time incentive that allowed companies in either 2004 or 2005 to repatriate accumulated foreign earnings via an 85% dividends-received deduction for certain controlled foreign corporation (CFC) dividends. Sec. 965(e)(2)(B) states that nondeductible CFC dividends will not be taken into account in determining the amount of any NOL for the tax year as well as NOL carryforwards and carrybacks under Sec. 172.
Thus, when a company carries its 2008 or 2009 NOL back to 2004 or 2005, it may not offset the nondeductible CFC dividend by the NOL carrybacks.
State and Local Tax Implications
States generally want to make their own decisions about what activities they want to provide tax benefits for. Thirty states and the District of Columbia do not allow NOL carrybacks but do permit taxpayers to carry forward losses to reduce future tax liabilities. Of the remaining states that allow carrybacks, a few states will conform to the federal NOL carryback provision, while others will decouple from the federal provision. Due to current state budgetary constraints, most states will decouple from the federal provisions for extended NOL carrybacks.
In some states, a state NOL deduction is available for the tax year only if the taxpayer takes a federal NOL deduction in the same year. Thus, if the federal NOLs are fully utilized due to the carryback claim, a company may never be able to use the NOL for state tax purposes in these states.
1 American Recovery and Reinvestment Act of 2009, P.L. 111-5.
2 Worker, Homeownership, and Business Assistance Act of 2009, P.L. 111-92.
3 Sec. 172(b)(1)(H).
4 Sec. 172(b)(1)(H)(iv).
5 Sec. 172(b)(1)(H)(iii).
6 Rev. Proc. 2009-52, 2009-49 I.R.B. 744.
7 American Jobs Creation Act of 2004, P.L. 108-357.
8 For more on the deduction, see Schurrer, “Sec. 199: Domestic Production Activities Deduction,” 41 The Tax Adviser 322 (May 2010).
9 IRS officials report that they have seen many taxpayers erroneously trying to claim both the NOL carryback and the Sec. 199 deduction (Bennett, “Manufacturing Deduction Impacted in Years New NOL Carryback Is Used, Officials Say,” BNA Daily Tax Report G-3 (April 28, 2010)).
10 A major stock acquisition is a 50% or more stock acquisition without a Sec. 338 election. An excess distribution is a corporation’s aggregate distribution for the year (including redemptions) that exceeds the greater of 150% of the average of such distribution for the prior three years or 10% of the stock’s fair market value (Sec. 172(b)(1)(E)(iii)).
11 Sec. 172(b)(1)(H)(i)(II).
12 Sec. 56(d)(1)(A)(i)(II).
13 Sec. 56(d)(1)(A)(ii).
14 Taxpayers could carry back FTCs arising prior to 2005 two years and forward five years. FTCs arising in 2005 and after may be carried back one year and carried forward 10 years. The American Jobs Creation Act of 2004 extended the carryforward period to 10 years for FTCs carried into tax year 2004. Taxpayers can carry forward federal NOLs 20 years.
Rachel Yin is a senior manager with Amper, Politziner & Mattia, LLP, in Edison, NJ. For more information about this article, contact Ms. Yin at email@example.com.