New Law Provides Tax Refund Opportunities for Businesses with Losses in 2008 or 2009

On November 6, 2009, President Obama signed into law the Worker, Homeownership, and Business Assistance Act of 2009 (the “Act”). Most of the attention generated by the Act has focused on the provisions that extended and expanded the first-time home buyer tax credit and extended unemployment benefits. Other noteworthy provisions of this legislation extend the temporary five-year net operating loss carryback period for businesses into 2009, and make this favorable provision available to nearly all businesses. This update focuses solely on the net operating loss carryback provisions of the Act, which will likely benefit most C corporations, sole proprietorships, S corporation shareholders, and partners/members of partnerships/limited liability companies that generate net operating losses during 2008 or 2009. The purpose of the longer carryback period is to allow businesses to raise needed cash by carrying back losses to prior profitable years and generating a refund for those prior years.
Expanded Net Operating Loss Carryback Provisions
Background. A net operating loss for federal income tax purposes may generally be carried back two years and carried forward twenty years. Alternatively, a taxpayer may elect to forego the right to carry back a net operating loss and agree to only carry the loss forward. The American Recovery and Reinvestment Act of 2008 (the “ARRA”) adopted a special provision that allows eligible small businesses to elect a three-, four- or five-year carryback period for net operating losses arising in a taxable year beginning or ending in 2008. An “eligible small business” includes a corporation, partnership/limited liability company or sole proprietorship with average annual gross receipts for the three-tax-year period ending with the loss year of $15 million or less.
Extended and Expanded Provision. The Act makes the five-year carryback provision available to most businesses (not just eligible small businesses), and extends the provision an additional year to include net operating losses incurred in taxable years beginning or ending in either 2008 or 2009--but not both. Therefore, an election under the Act may be made for either a 2008 NOL or a 2009 NOL--but not for both.
The amount of the net operating loss that can be carried back under the Act to the fifth taxable year preceding the loss year may not be greater than 50 percent of the taxable income for that taxable year, determined without taking into account any net operating loss from the loss year or any subsequent tax year. The remaining loss may offset 100 percent of the taxable income for the remaining carryback years. The Act also temporarily suspends the 90 percent limitation on the use of alternative tax NOL deductions attributable to carrybacks of an applicable net operating loss for which the extended carryback period has been elected. This provision applies to taxable years ending after December 31, 2002. In applying the 50 percent of taxable income limitation to the carryback of an alternative tax NOL to the fifth preceding taxable year, the limitation is applied based upon alternative minimum taxable income.
Special Provisions for Eligible Small Businesses. The Act includes special provisions for “eligible small businesses” that meet the gross income test described above. First, eligible small businesses may take advantage of the five-year carryback provisions for both the 2008 and 2009 tax years, provided a timely election is made pursuant to the provisions of the ARRA for any 2008 loss. If a timely election under the ARRA is not made with respect to its 2008 taxable year, the business may only elect the five-year carryback under the Act for either a 2008 loss or a 2009 loss. Second, the 50 percent limitation on the carryback of net operating losses to the fifth taxable year preceding the loss year does not apply to eligible small businesses that elect to carry back a 2008 loss under the provisions of the ARRA, regardless of whether such election is made before or after enactment of the Act. This means that an eligible small business can elect under the ARRA to offset its entire taxable income for the fifth taxable year preceding the year of its 2008 net operating loss. Any election by the eligible small business under the Act to carry back a 2009 loss to the fifth preceding taxable year will be subject to the 50 percent of taxable income limitation.
Life Insurance Companies. Life insurance companies may elect to increase the present law three-year carryback period to either four or five years for any loss from operations for any taxable year beginning or ending in either 2008 or 2009--but not both. The 50 percent of taxable income limitation applies to losses carried back to the fifth preceding taxable year.
Excluded Taxpayers. The five-year carryback provision of the Act generally does not apply to any taxpayer or member of an affiliated group in which the federal government has acquired or acquires an equity interest, including any warrant or other right to acquire an equity interest, pursuant to the Emergency Economic Stabilization Act of 2008. Any equity interest or right to acquire an equity interest is disregarded for this purpose if acquired by the federal government after enactment of the Act from a financial institution, pursuant to a program established by the Secretary of the Treasury to increase the availability of credit to small businesses using funding made available under the Emergency Economic Stabilization Act of 2008. The provision also does not apply to the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation.
Election. Taxpayers must make an affirmative election in order to utilize the extended three-, four- or five-year carryback period provisions of the Act. The election must be made by the due date, including extensions, for filing the tax return for the last taxable year beginning in 2009. The election is irrevocable.
Revocation of Prior Election. The Act also allows taxpayers to revoke an election that was made to waive the carryback period altogether with respect to any net operating loss for a taxable year ending before the date of enactment of the Act, provided such revocation is made by the extended due date for filing the tax return for the last taxable year beginning in 2009.
Analysis. As a result of the new provisions, most businesses now have three choices for NOLs generated in 2008 or 2009: (1) elect a three-, four-, or five-year carryback period, (2) make no elections and carry back NOLs under the present law two-year period and carry any remaining NOLs forward for up to 20 years, or (3) elect to forego any carryback and only carry the losses forward for up to 20 years. Although the new carryback provisions of the Act are generally favorable, taxpayers should carefully analyze the consequences of each of these options to ensure the maximum tax benefit is obtained. This analysis should consider federal and state income tax consequences and potential financial statement consequences, among others.