Businesses experiencing operating losses now have more tax-saving options

On November 6, President Obama signed into law the Worker, Homeownership and Business Assistance Act of 2009 (WHBAA). In addition to extending unemployment benefits for millions of Americans and enhancing the homebuyers credit, the Act extends and expands a popular tax break for businesses: the five-year net operating loss (NOL) carryback election.

More years, more types of businesses

Generally, when business deductions exceed gross income, the difference is an NOL for tax purposes and may be carried back two years to offset income. This generates a tax refund, providing a cash infusion in times of loss. Any loss that’s not absorbed is carried forward up to 20 years. In the case of a flow-through entity, such as a partnership, limited liability company (LLC) or S corporation, the NOL flows through to the owner’s tax return, but additional rules apply that affect the amount of NOL the owner can use to offset income.

The American Recovery and Reinvestment Act of 2009 (ARRA) allowed taxpayers to elect to carryback 2008 NOLs (NOLs for taxable years beginning or ending in 2008) from qualifying small businesses (businesses with average gross receipts of $15 million or less for the three years ending with the loss year) for three, four or five years instead of two. WHBAA expands the longer carryback option to businesses that don’t qualify as “small” and extends it to 2009 NOLs (NOLs for taxable years beginning or ending in 2009).

Because the biggest refund that taxpayers can get from carrying back an NOL is an amount equal to the taxes paid in the carryback years, having additional carryback years available can be particularly helpful if little or no income was earned in the two years immediately preceding the loss.

Under WHBAA, generally taxpayers can apply the longer carryback to only one tax year’s NOL and to offset only 50% of income in the fifth year back, 100% in the other four. For qualifying small businesses, taxpayers can apply the longer carryback to both 2008 and 2009 NOLs, and the 50% limit applies only to 2009 NOLs.

Taxpayers also have the option to waive the carryback period and carry the entire loss forward. This may be beneficial if the marginal tax rate in the carryback years is unusually low or if the alternative minimum tax (AMT) in prior years makes the carryback less beneficial.

An NOL in action

Let’s say your closely-held C corporation experiences a $100,000 NOL in the 2009 tax year. Under WHBAA, you can elect to carry the NOL back five years:

• If your business’s 2004 taxable income was $50,000, you can offset 50% of it, or $25,000, with the 2009 NOL, and your business will receive a refund of the $3,750 of tax paid on that income.
• If 2005 taxable income was also $50,000, you can offset 100% of it with the remaining $75,000 of 2009 NOL, and your business will receive a refund for 100% of the 2005 taxes paid, or $7,500.
• If 2006 taxable income was also $50,000, you can then use up the last $25,000 of the 2009 NOL and receive a refund of $3,750.
• Your total refund from carrying back the NOL, therefore, will be $15,000.

But let’s say you’re adding a new product line in 2010 that you anticipate will significantly boost profits, pushing your company into a higher tax bracket. In that situation, if you can afford to forgo the current cash flow boost that an NOL carryback would provide, you may be better off carrying forward the entire NOL.

If, for instance, your business is projected to have a $100,000 profit in 2010, and presuming the tax rates don’t change, carrying forward the NOL may save $22,250 in taxes — $7,250 more than if you carry it back. The savings may be even greater if your business expects a higher profit in 2010.

Year-end tax planning tips

If you expect that your business will experience a 2009 NOL, consider strategies for maximizing it. For example, if you need to make equipment or other asset purchases within the next few months, you may want to do so before year end. You could take advantage of 50% bonus depreciation (generally available only for purchase of qualified assets placed in service this year) to maximize your expense deduction and increase your NOL.

If your business uses the accrual method of accounting for tax purposes, you also can increase this year’s NOL with inventory write-downs, bad debt write-offs, or a reduction of accrued expenses. Cash basis businesses may be able to increase an NOL by accelerating depreciation deductions, maximizing retirement plan funding, selling off devalued assets, or prepaying deductible expenses before year end.

Don’t wait

You may need to take steps before year end to maximize the benefit of the five-year NOL carryback option. So if your business has suffered operating losses, don’t wait to explore how you might turn them into a tax advantage. But complex rules apply, so be sure to consult a tax advisor. We’d be pleased to work with you to determine the best strategy for utilizing an NOL, as well as other strategies to consider in your 2009 year-end tax planning. 

If you have specific questions, please contact:

    David A. Erb, CPA, MST, Principal                           207-541-2255                             derb@bdmp.com