For taxable years ending in 2001 and 2002, the Job Creation and Worker Assistance Act of 2002 extended the carryback period for net operating losses to five years.
Before the Act, the carryback period was generally two years but was three years for certain eligible losses, such as casualty losses of individuals and certain losses attributable to a presidential declared disaster. However, under both pre- and post-act law, a taxpayer may elect to forgo carrying back an NOL.
Recommendation: A taxpayer should consider waiving the carryback if it doesn’t need an immediate refund, and if carrying forward the loss will result in greater tax savings. There would be greater tax savings if the taxpayer were in a higher tax bracket in the year to which the NOL is carried forward than its tax bracket in the year or years to which the NOL would have to have been carried back.
Unless that election is made, the entire amount of the NOL for a taxable year has to be carried first to the earliest taxable year to which it could be carried, then to the next earliest, and so on, in chronological order, until it is completely absorbed.
Example (1): Your client, a C corporation, had taxable income of $200,000 for its taxable year ending Dec. 31, 1996, $100,000 for its taxable year ending Dec. 31, 1997, $60,000 for its taxable year ending Dec. 31, 1998, $50,000 for its taxable year ending Dec. 31, 1999 and $80,000 for its taxable year ending Dec. 31, 2000. Your client has a $450,000 NOL for its taxable year ending Dec. 31, 2001 and an extension until Sept. 15, 2002 to file its 2001 tax return.
Under the act, $200,000 of your client’s NOL for 2001 is carried back to its 1996 taxable year, $100,000 to its 1997 taxable year, $60,000 to its 1998 taxable year, $50,000 to its 1999 taxable year and $40,000 to its 2000 taxable year. The entire NOL of $450,000 is used up by carrybacks.
Under pre-act law, your client could have carried back $50,000 to its 1999 taxable year, and $80,000 to its 2000 taxable year. This would have left $320,000 of NOL that could not be used up by carrybacks. Instead, the $320,000 would have to be carried forward until completely used up (or until it expired).
Under the act, your client is able to get a total refund of past-year taxes of $107,000 ($61,250 for 1996, $22,250 for 1997, $10,000 for 1998, $7,500 for 1999 and $6,000 for 2000). Under pre-act law, the refund would have been only $22,950 ($7,500 for 1999 and $15,450 for 2000). Any further tax savings would depend on the amount of your client’s taxable income in years to which the balance of the NOL would be carried forward.
How to obtain a refund from an NOL carryback. A corporation uses either Form 1139, Corporate Application for Tentative Refund, or Form 1120X, Amended U.S. Corporation Income Tax Return, to receive a refund due to an NOL carryback. An individual uses either Form 1045, Application for Tentative Refund, or Form 1040X, Amended U.S. Individual Income Tax Return, to get such a refund. The refund will be faster if the corporate taxpayer uses Form 1139 or the individual taxpayer uses Form 1045.
A taxpayer cannot file Form 1139 or Form 1045 before filing the return for the NOL year. Form 1139 or Form 1045 must be filed no later than one year after the year the taxpayer sustains the NOL. If a taxpayer does not file Form 1139 or Form 1045, it must file Form 1120X or Form 1040X within three years of the due date, plus extensions, for filing the return for the year in which the NOL is sustained.
Electing not to have the five-year carryback period apply. A taxpayer may elect to have the carryback period for the loss year determined without regard to the temporary five-year carryback period rule. The election must be made in the manner determined by the Internal Revenue Service by the due date (including extensions of time) for filing the taxpayer’s return for the taxable year of the NOL. Once the election is made for a taxable year, the election is irrevocable for that year.
If a taxpayer elects to forgo the five-year carryback period, the losses are subject to the rules that otherwise would have applied without the five-year rule, i.e., they would be carried back two years (three years in certain cases) and any excess would have to be carried forward.
Determining whether to waive the five-year carryback will depend on the size of the NOL, the taxpayer’s past and expected future tax brackets and the taxpayer’s need for immediate cash from a refund (even if total tax savings might be higher if part of the NOL were carried forward).
Example (2): Your client, a C corporation, has a net operating loss of $200,000 for its taxable year ending Dec. 31, 2001. It had taxable income of $50,000 for its taxable year ending Dec. 31, 1996, $75,000 for its taxable year ending Dec. 31, 1997, $75,000 for its taxable year ending Dec. 31, 1998, $300,000 for its taxable year ending Dec. 31, 1999 and $100,000 for its taxable year ending Dec. 31, 2000. Your client has an extension of time until Sept. 15, 2002, to file its 2001 Form 1120.
If it does not elect out of the five-year carryback period for an NOL that arises in a taxable year ending in 2001, it will have to carryback $50,000 of its NOL to its 1996 taxable year, $75,000 to its 1997 taxable year and $75,000 to its 1998 taxable year. This will result in your client getting a refund of $35,000 from the carryback ($7,500 for 1996, $13,750 for 1997 and $13,750 for 1998).
If it does elect out, your client will carry all of its NOL of $200,000 back to 1999, and will get a refund of $78,000 (39 percent of its pre-carryback income over $100,000) or $43,000 more than the refund it would have received if it didn’t elect out.
Example (3): The same facts apply as in Example (2), plus your client did elect out of the five-year carryback period for its 2001 NOL and expects to have a $300,000 NOL for its taxable year ending Dec. 31, 2002. Even though your client elected out of the five-year carryback for its 2001 NOL, it is not required to elect out for purposes of its 2002 NOL since the election out applies only to the NOL for the year for which it is made. Accordingly, your client should be able to carry back $75,000 of its 2002 NOL to 1997, $75,000 to 1998, $100,000 to 1999 (to use up the balance of its taxable income for 1999 that’s left after carrying back the $200,000 2001 NOL to that year) and $50,000 to 2000.
If your client does elect out for its 2002 NOL, as well, it would only be able to carry $100,000 of its NOL for that year back (to 2000 when it had taxable income of $100,000), and would have to carry the $200,000 balance of the 2002 NOL forward.
No election out if due date for filing return has passed. As noted above, the election out of the five-year carryback period must be made by the due date (including extensions) for filing the return for the year of the NOL. This apparently means that some taxpayers, especially fiscal year taxpayers, are not eligible to elect out. A literal reading of IRC §172(j) may even require them to file amended returns to claim a reduced refund.
Hopefully, either Congress will pass a technical correction to allow such taxpayers to elect out, or the IRS will adopt a liberal interpretation that will allow taxpayers that already filed their returns time to elect out.
The best way to deal with this problem would seem to be to create a presumption that taxpayers who already filed their returns elected out of the five-year carryback period unless they file amended returns to claim the benefit of the five-year carryback.
Example (4): Same facts as Example (2) except that your client’s taxable year is a fiscal year ending Jan. 31, and it already filed its return for the year in which it had its $200,000 NOL, i.e., its year ending Jan. 31, 2001. It carried all of its NOL back to its taxable year ending Jan. 31, 1999, the year in which it had taxable income of $300,000. Accordingly, as a result of the carryback, it received a refund of $78,000.
IRC §172(j) seems to require that your client must carry its NOL for its year ending in 2001 back to its years ending in 1996 ($50,000 of taxable income), 1997 ($75,000 of taxable income) and 1998 ($75,000 of taxable income). If this is so, your client would have to give back $43,000 of its refund (the excess of the $78,000 it received over the total of $35,000 in refunds that it would be entitled to if the NOL were carried back to years ending in 1996 ($7,500); 1997 ($13,750) and 1998 ($13,750).
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