Gains & Losses
Section 13 of the Worker, Homeownership, and Business Assistance Act of 2009, P.L. 111-92 (WHBAA), expanded the net operating loss (NOL) carryback provisions granted earlier to small businesses by the American Recovery and Reinvestment Act of 2009, P.L. 111-5 (ARRA), for NOLs incurred in tax years beginning or ending in 2008 or 2009. As amended by the WHBAA, Sec. 172(b)(1)(H) allows almost all businesses to make an irrevocable election for an eligible loss year to carry back their NOLs for three, four, or five years. Moreover, Sec. 172(b)(1)(H) allows a taxpayer that made an election to carry back an NOL under the ARRA provisions to also make a carryback election under the WHBAA for another tax year.
As discussed below, what taxpayers may overlook in deciding whether to make this election is the potential future tax benefit when the NOL is not fully utilized in the carryback period and is available to be carried forward to post-loss tax years. Because the Sec. 172(b)(1)(H) election must be made no later than the due date (including extensions) for the taxpayer’s tax year beginning in 2009, the opportunity for this future benefit will expire soon for most taxpayers.
The 90% AMT Limitation
In computing alternative minimum taxable income (AMTI), Sec. 56(a)(4) provides that a taxpayer must use the alternative minimum tax net operating loss (ATNOL) deduction in lieu of the NOL deduction allowed for regular tax purposes. Moreover, the ATNOL deduction is generally limited to 90% of AMTI determined without regard to the ATNOL deduction and the deduction under Sec. 199. However, to provide an additional tax benefit to businesses that make the Sec. 172(b)(1)(H) election, the WHBAA amended Sec. 56(d)(1)(A)(ii)(1) to effectively eliminate the 90% limitation for any ATNOL deduction attributable to an NOL for which the Sec. 172(b)(1)(H) election has been made. The WHBAA also amended the normal ordering rules (i.e., the earliest NOLs are used first) for purposes of claiming an ATNOL deduction.
Under Sec. 56(d)(1)(A), as amended, AMTI is first offset by any available ATNOLs up to 90% of AMTI, excluding a Sec. 172(b)(1)(H) NOL and other special case NOLs such as qualified Gulf Opportunity losses. The balance of AMTI remaining for the carryforward year is then offset by the Sec. 172(b)(1)(H) and other special case NOLs. This reordering rule effectively makes the Sec. 172(b)(1)(H) NOL the last in order of use for the first 90% of AMTI and the last in order of use for offsetting the final 10% of AMTI. The following examples illustrate how this reordering provides an advantage with respect to the Sec. 172(b)(1)(H) NOL.
Examples of the Effects of Sec. 172(b)(1)(h) Election
Companies X, Y, and Z are all C corporations that have been calendar-year taxpayers since their formation. None is a qualified small business (QSB) by the definition of Sec. 172(b)(1)(H)(v), none has had a corporate equity reduction transaction (CERT) as described in Sec. 172(b)(1)(E), and none has ever been taxed as a part of a consolidated group, nor do any of the companies own a controlling stake in any other corporation. None of the corporations is required to make any adjustments in the computation of AMTI, and they claim no general business credits on Form 3800, General Business Credit. The 2009 tax rates and exemptions will remain unchanged for future tax years.
X incorporated on January 1, 2005, and earned taxable income, before special deductions, of $1 million, $2 million, and $1 million for 2005, 2006, and 2007, respectively. X also sustained NOLs in 2008 and 2009 in the amounts of $4 million and $2 million, respectively. Y incorporated on January 1, 2007, and sustained an NOL for 2007 of $1 million and earned taxable income, before special deductions, of $1 million for 2008. Y also sustained a $4 million NOL for 2009 and earned taxable income, before special deductions, of $1 million for 2010. Z incorporated on January 1, 2008, and sustained NOLs of $1 million, $3 million, and $2 million for 2008, 2009, and 2010, respectively. In 2011, Z earned taxable income, before special deductions, of $1 million. (See Exhibit 1.)
Assuming that X made no election under Sec. 172(b)(3) to waive a carryback, it will carry back the NOL sustained in 2008 to the two previous tax years, resulting in a refund of all previous regular tax liability. After using all regular tax NOLs and ATNOLs, X will have paid $340,000 in regular tax for 2005, along with a total of $46,500 AMT for 2006 and 2007 (see below). X will have an NOL carryforward of $3 million and an ATNOL carryforward of $3.3 million for 2010.
Regardless of whether an election under Sec. 172(b)(3) has been made, X can still make a Sec. 172(b)(1)(H) election for an NOL generated in either 2008 or 2009. If the election is made for 2008, X will receive a refund of regular tax liability of $340,000 for 2005, and it will not be subject to AMT. X will also receive an additional refund of $46,500 for 2006 and 2007 based on the benefit of bypassing the 90% limitation. X will still have the 2009 NOL available as a carryforward to 2010. (See Exhibit 2.)
As demonstrated in the case of Y, the prior benefits of making the Sec. 172(b)(1)(H) election extend beyond refunds for the prior year’s taxes. If no Sec. 172(b)(1)(H) election is made, Y will have an AMT liability of $12,000 for 2010, an NOL carryforward of $3 million, and an ATNOL carryforward of $3.2 million to 2011.
If Y makes a Sec. 172(b)(1)(H) election for the 2009 NOL, it will recover $12,000 relating to the AMT that would otherwise be paid in 2008. Because the electing year NOL maintains its ability to bypass the 90% limitation on a going-forward basis, Y will receive the additional benefit of paying no tax in 2010. This results in a total savings of $24,000, all relating to AMT. Y will also have an NOL carryforward of $3 million and an ATNOL carryforward of $3 million for 2011. (See Exhibit 3.)
If no Sec. 172(b)(1)(H) election is made, Z will have an AMT tax liability of $12,000 for 2011. Although there is no current benefit for Z to make the election for either the 2008 or 2009 NOLs, the election can provide Z with future tax benefits. If the election is made for 2009 (the year with the greater loss), the NOL will be an elected NOL, which will result in no tax due in 2011; this is a tax savings of $12,000 relating to the AMT that otherwise would have been paid in 2011. Z will now have an NOL carryforward of $5 million, a normal (limited to 90% of AMTI) ATNOL carryforward of $2.1 million, and an electing ATNOL carryforward of $2.9 million, all to 2012. Note that the ordering rules have changed and that two separate pools have been created: one able to offset the first 90% of AMTI generated and a second to offset 100%. (See Exhibit 4.)
[Clarification: After the September issue went to press, the IRS released Notice 2010-58, containing guidance on the election. Q&A-10 in that notice clarifies that a taxpayer in Company Z’s situation would not be allowed to make the Sec. 172(b)(1)(H) election because it would not have a third, fourth, or fifth preceding tax year to which to carry its NOL back.]
Per Rev. Proc. 2009-52, a taxpayer may make a Sec. 172(b)(1)(H) election by attaching an election statement to the federal income tax return for the year of election (attach to an amended return if a federal income tax return was previously filed). In an effort to ease the reporting requirements for taxpayers, the IRS allows corporations to attach the election statement with Form 1139, Corporation Application for Tentative Refund, in lieu of making an amended return filing on Form 1120X, Amended U.S. Corporation Income Tax Return.
The election statement must include the tax year for which the Sec. 172(b)(1)(H) election is being made, the length of the extended carryback period (three, four, or five years), and that the taxpayer is not a TARP recipient or an affiliate of a TARP recipient. In situations where the taxpayer has previously checked the box to waive the NOL carryback, additional language must be included in the election statement indicating that the taxpayer is revoking the previously filed election.
The due date for making a valid election under Sec. 172(b)(1)(H) is the due date, including extensions, for filing the return for the taxpayer’s last tax year beginning in 2009 (September 15, 2010, for calendar-year filers). Fiscal-year filers would have additional time to make the election, giving the taxpayer more time to select the most favorable eligible tax year to make this election.
The addition and expansion of the Sec. 172(b)(1)(H) election has created numerous tax planning opportunities for corporations that have sustained NOLs. Although it was not the original intention of the Sec. 172(b)(1)(H) election, the ability to change the character of election-year ATNOLs creates an additional benefit of making this election. When advising a client on making the election, it is important to consider the impact on future-year AMTI and ATNOL carryforwards. Because this election is irrevocable when made, it should be done with caution after assessing a client’s past tax liability and future projections for regular and alternative minimum taxable income.
Editor: Frank J. O’Connell Jr., CPA, Esq.
Frank J. O’Connell Jr. is a partner in Crowe Horwath LLP in Oak Brook, IL.
For additional information about these items, contact Mr. O’Connell at (630) 574-1619 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.