Net Operating Loss Carry Back (NOL)

The key to determining the optimal carry back period may be correctly calculating the minimum tax credit net operating loss. The American Recovery and Reinvestment Act of 2009 (ARRA) permits an eligible small business to elect to increase the net operating loss (NOL) carry back period for a 2008 NOL from two years to five years.

The Worker, Home ownership, and Business Assistance Act of 2009 (WHBA) extended ARRA to include 2009 NOLs and expanded the ARRA NOL election to include most taxpayers with NOLs, except those receiving troubled asset relief program (TARP) funds from the Federal government. Taxpayers have until the due date (including extensions) for filing their 2009 returns to elect to extend the NOL carry back period beyond the normal two-year period.

The election to extend the NOL carry back period presents a unique opportunity for tax professionals to counsel clients hit hard by the downturn in the economy. Correctly calculating the tax refund generated by the carry back is critical to making the election decision.

For individual taxpayers, alternative minimum tax (AMT) may offset a portion of the tax refund generated by the carry back. This article briefly reviews the ARRA and WHBA carry back election and then focuses on how to correctly calculate an individual taxpayer’s alternative tax NOL and minimum tax credit NOL used in carry back years. Correctly calculating the minimum tax credit NOL is particularly important because the Emergency Economic Stabilization, Energy, Extenders and AMT Relief Acts of 2008 amended IRC §53(e) to make long-term unused minimum tax credit refundable over a two year period for individual taxpayers.

ARRA and WHBA and the Carry back Election. ARRA, which was signed into law by President Obama on February 17, 2009, allows an eligible small business to elect to increase the carry back period of a 2008 NOL from two years to three, four, or five years. ARRA defines an eligible small business as a corporation, partnership, or a sole proprietorship that has average annual gross receipts of $15 million or less over the three tax years ending with the tax year in which the NOL arose. The election to increase the carry back period under ARRA could be made by an eligible small business for any tax year beginning or ending in 2008.

WHBA became law on November 6, 2009, and extended the five-year NOL carry back election to an NOL for a taxable year ending after December 31, 2007, and beginning before January 1, 2010. In addition, WHBA allows any taxpayer (not just an eligible small business) that did not receive TARP funds to elect to extend the NOL carry back period. The election is irrevocable and generally may be made for only one taxable year. However, an eligible small business that made or makes an election under ARRA may also make an election under WHBA for another taxable year.

WHBA limits the amount of an NOL that any taxpayer (including an eligible small business) may carry back to the fifth tax year to fifty percent of the taxpayer’s taxable income calculated without taking the NOL carry back into account. This fifty-percent limitation is also applied separately to alternative minimum taxable income (AMTI).

The excess NOL over the fifty percent limit may then be carried back to the fourth preceding tax year by the taxpayer. The fifty percent NOL limit only applies to the fifth year carry back and does not apply to any other carry back year. Finally, WHBA suspends the general rule limiting a taxpayer’s alternative tax NOL to ninety percent of AMTI for taxpayers who elect to extend the NOL carry back period for 2008 and 2009 NOLs.

Rev. Proc. 2009-52, provides guidance to taxpayers electing an extended carry back period under WHBA. Note that taxpayers who previously elected to waive a carry back period for a taxable year ending before November 6, 2009, may revoke that election and elect the extended carry back period.

However, an election to waive a carry back period for a taxable year ending on or after November 6, 2009, is irrevocable. Generally, taxpayers have until the due date (including extensions) for filing their 2009 tax returns to elect the extended NOL carry back period.

Calendar-year individual taxpayers have until October 15, 2010, to amend a 2009 return on which no carry back election was made.

Alternative Tax and Minimum Tax Credit NOL Deduction Calculations Used in carry back year.

The expansion of the extended NOL carry back election to all taxpayers except TARP fund recipients means that tax returns of individuals owning partnership interests and S corporation stock with 2008 or 2009 NOLs should be reviewed to determine which carry back period is most advantageous for them. Since carrying back an NOL of a high or moderate income individual may trigger AMT in the carry back year, any analysis will be incomplete if it does not include an accurate calculation of the minimum tax credit in the years(s) after the carry back year.

For example, assume a married couple has a 2009 NOL that, when carried back to 2007, would generate a regular tax refund of $20,000. Assume further that if the couple elected to carry back the 2009 NOL to 2004, it would reduce their regular tax by $25,000 but cause the couple to pay an additional AMT of $10,000. At first glance, it appears that the net savings of carrying back the 2009 NOL to 2004 would be $15,000. However, if the longer NOL carry back creates a minimum tax credit of more than $5,000 and the couple can use the minimum tax credit in any year after 2004, the NOL carry back to 2004 will produce a larger tax refund than carrying the NOL back to 2007. The couple will likely use the minimum tax credit in a later tax year because the long-term unused minimum tax credit is refundable for individual taxpayers.

The technical definition of the minimum tax credit is found in §53(b). The minimum tax credit is defined in §53(b)(1) as the adjusted net minimum tax over the prior year minimum tax credit allowed. The adjusted net minimum tax is defined in §53(d)(1)(B)(i) as the excess of net minimum tax (AMT) over the amount that would be the AMT if only the adjustments and items of tax preference specified in §53(d)
(1)(B)(ii) were taken into account.

For tax years beginning before January 1, 2013, a maximum of 50 percent of the long-term unused minimum tax credit is refundable for individual taxpayers each year.

Long-term unused minimum tax credit is defined in §53(e)(3) as that portion of the minimum tax credit attributable to the adjusted net minimum tax for taxable years before the third taxable year immediately preceding the tax year.

To correctly calculate the minimum tax credit, it is necessary to first calculate the minimum tax credit NOL, which is calculated differently than the alternative tax NOL. While the alternative tax NOL is calculated using all AMT adjustments and preferences, the minimum tax credit NOL is calculated using only AMT exclusion items. AMT timing/deferral adjustments are not included in the minimum tax credit NOL calculation. The reason the minimum tax credit NOL is calculated differently than the alternative tax NOL lies in the purpose of the minimum tax credit, which is to provide equity to a taxpayer when AMT timing differences reverse. A taxpayer may only carry forward the minimum tax credit to reduce the excess of regular tax over tentative minimum tax in future tax years when AMT timing differences reverse. A taxpayer may not carry the minimum tax credit back.

The extended NOL carry back election created by ARRA and enhanced by WHBA provides tax professionals the opportunity to appropriately counsel clients who have NOLs arising in the last two years. The carry back election decision can be complicated, particularly when the client is an individual paying AMT as a result of the carry back. Tax professionals need to know how to correctly calculate the minimum tax credit NOL that is generated in the loss year because many tax software packages do not make this calculation. If the proper minimum tax credit NOL calculations are made, the tax professional will be able to determine whether it is advantageous for a client to carry an NOL back for more than two years and will be able to assist the client to maximize the economic benefit of a minimum tax credit generated by the carry back.

John R. Dundon, EA [720-234-1177, John@JohnRDundon.com]. John is a lifelong student of the US Tax Code; enrolled with the United States Treasury Department to practice before the IRS (Enrolled Agent # 00085353); under contract with the IRS as a Certified Individual Taxpayer Identification Number (ITIN) Acceptance Agent; regulated under USC 31 Section 330 & USC 26 Section 7525a.3.A; governed under US Treasury Cir. 230.

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Posted in Net Operating Loss, NOL

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