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Overview of Extended Carryback Period for 2008 NOLs By Carla Neeley Freitag, Esq. TaxResearchAndWriting.com, Merritt Island, FL The American Recovery and Reinvestment Act of 2009 (2009 ARRA or the Act) offers relief to small businesses which lack sufficient cash flow to sustain their current obligations.1 Qualifying small businesses may elect to extend the net operating loss (NOL) carryback period for 2008 NOLs from two years to up to five years.2 This article points out the highlights of the amendment to §172, which governs the deduction of net operating losses. Carrybacks vs. Carryovers A net operating loss occurs when a taxpayer's business deductions exceed its gross income. Section 172 allows taxpayers to carry back a net operating loss to the two taxable years prior to the loss and to carry the loss forward for an additional 20 years after the loss year.3 NOLs offset taxable income in chronological order beginning with the first year in the carryback period and ending with the last year in the carryover period. An NOL carryback generates present cash in the form of a tax refund, whereas a carryover reduces taxes in future years. A longer carryback period is favorable for small businesses. Many businesses routinely borrow funds temporarily to meet payroll and pay bills until their cash position improves. Due to the current economic conditions, however, credit may be unavailable. A refund from an NOL carryback provides an infusion of cash that could make the difference between success and failure of a struggling business.4 If a business started declining prior to the recognition of the current financial crisis, it may have little or no taxable income in 2006 and 2007 to absorb a 2008 NOL. The loss can be carried forward, but that will not generate any tax savings until 2010. Being able to apply an NOL against the taxable income of the previous five years instead of the previous two years means that a business can qualify for a larger refund or, if the business also had losses in the two prior years, the taxpayer may be eligible for a refund from the other three years. Note: Under the House version of the legislation, a business was required permanently to reduce by ten percent any net operating loss for which the extended period was elected. The reduction did not appear in the final legislation.5 Eligible Small Businesses The 2009 ARRA restricts use of the extended NOL carryback period to eligible small businesses. The Act covers corporations, partnerships, and sole proprietorships with average annual gross receipts that do not exceed $15 million for the three-year period ending with the loss year.6 Thus, with respect to a 2008 loss, a corporation is an eligible small business if its average annual gross receipts for the period 2006 through 2008 do not exceed $15 million. Comment: While perceptions of what constitutes a “small business” may differ, many taxpayers were expecting that the five-year carryback rule would apply to taxpayers with average annual gross receipts exceeding $15 million, many of whom also need the immediate access to cash that the Act was intended to provide. Losses Covered The Act applies to “applicable 2008 net operating losses.” Specifically, a 2008 net operating loss is either:7 • The taxpayer's NOL for any taxable year ending in 2008; or • If the taxpayer elects not to have the foregoing rule apply, the NOL for any taxable year beginning in 2008. The new law applies only to NOLs arising in taxable years ending after 2007, absent a contrary provision.8 Thus, if a taxpayer had a 2007 net operating loss which was carried back to 2005 and 2006, the taxpayer cannot use the new law to carry the loss back to earlier years instead. Unless the new five-year carryback provision is extended, a 2009 NOL will be a net operating loss carryback for 2007 and 2008. Note: The House version of the new law applied the extended carryback period to both 2008 and 2009 NOLs. The final version, however, used the Senate mark-up, which limited the scope of the new provision to 2008 losses.9 Election to Use Extended Carryback Period Taxpayers must affirmatively elect to take advantage of the extended carryback period.10 An election is irrevocable. The election is made in substantially the same manner as other elections under §172, such as the election to waive the carryback period.11 The deadline for making an election is the due date (including extensions) of filing the return for the year of the loss. The new law states that an election can be made only with respect to one taxable year. Length of Extended Carryback Period A taxpayer may elect to use an extended carryback period of three, four, or five years.12 Thus, for a 2008 NOL, the carryback period under the general rule consists of the years 2006 and 2007; if an election is made to use the extended carryback period, however, the carryback period will be either 2003 through 2007 (five years), 2004 through 2007 (four years), or 2005 through 2007 (three years).13 Conclusion Amid news of bailouts of giant financial institutions and car manufacturers, it is encouraging to see a provision that offers immediate relief for small businesses. From a policy perspective, a relief measure which merely accelerates the recognition of an NOL deduction from a later year to an earlier year is preferable to using public funds to make loans to, or invest in, small businesses. The ability to use three additional years of taxable income to absorb a current loss is significant, and the IRS expects a flood of refund applications.14 Small businesses and their advisors need to evaluate whether the extended carryback period for 2008 losses would be beneficial. 1 §172(b)(1)(H)(i)(I), as added by the American Recovery and Reinvestment Act of 2009, P.L. 111-5, §1211(a) (Feb. 17, 2009), effective for NOLs arising in taxable years ending after Dec. 31, 2007, unless provided otherwise. P.L. 111-5, §1211(d)(1). See also IRS News Release, Questions and Answers for ARRA §1211 5-Year Net Operating Loss Carryback Election for Small Businesses (Mar. 16, 2009). 2 The strategy of temporarily extending the NOL carryback period to counter unfavorable economic conditions was used in the recent past. In the wake of Hurricane Katrina, Congress implemented a five-year carryback period for 2001 and 2002 NOLs. Pre-2009 ARRA §172(b)(1)(H).The language of former §172(b)(1)(H) concerning the extended carryback for 2001 and 2002 NOLs was replaced with the new extended carryback for 2008 losses. 3 While the two-year carryback applies as a general rule, there are various exceptions. For example, a 10-year carryback period is allowed for specified liability losses, which are losses attributable to product liability or to liability under certain federal or state laws. §172(b)(1)(C), (f). Farming losses can be carried back for five years. §172(b)(1)(G). 4 IR-2009-26 (Mar. 16, 2009), paraphrasing IRS Commissioner Doug Shulman. 5 See H.R. 111-16 (Conference Report), 1st Cong., 1st Sess., 545 (Feb. 12, 2009) (Conference Report). 6 §172(b)(1)(H)(iv), as added by the 2009 ARRA. 7 §172(b)(1)(H)(ii), as added by the 2009 ARRA. 8 2009 ARRA §1211(d)(1). 9 See Conference Report at 545. 10 §172(b)(1)(H)(iii), as added by the 2009 ARRA. 11 See §172(b)(3). 12 §172(b)(1)(H)(i)(I), as added by the 2009 ARRA. See Rev. Proc. 2009-19, 2009-14 I.R.B. 747. 13 If a fiscal year taxpayer chooses the fiscal year beginning in 2008 as the loss year, the carryback periods will be 2004-2008, 2005-2008, or 2006-2008. §172(b)(1)(H)(ii)(II). 14 IR-2009-26 (Mar. 16, 2009).

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