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A new law gives corporations a chance to apply net operating losses to income generated in good years, going back to 2003.
Marie Leone, CFO.com | US
November 11, 2009
There's something for everyone in the aptly named Worker, Homeownership, and Business Assistance Act of 2009, an economic-recovery package signed into law last Friday. The statute, which garnered bipartisan support, provides added unemployment insurance for those who have been out of work the longest and expands the existing homebuyer credit. CFOs, however, might be more interested in the new law's extension of a small-business tax benefit for another year and the fact that it opens the program up to midsize and large businesses.
Specifically, the law increases the net operating loss (NOL) carryback provision from two years to five years for corporate losses incurred in 2008 and 2009. That means losses from those two years can be used to offset taxable income paid in the prior five years, thereby providing corporate taxpayers with a cash refund.
Corporations are coveting NOLs (meaning losses for accounting purposes alone, of course) and are going to great lengths to preserve them. For instance, this year both Ford Motor Co. and Citigroup adopted so-called poison pills to prevent a technical change of ownership that would have triggered the loss of $19 billion and $44 billion worth of NOLs, respectively.
"The expansion of the NOL carryback period will accelerate a $33 billion refund of previously paid taxes for much of Corporate America in a very short period of time," says John McMahon, director for business tax services at Ernst & Young. The new carryback provision includes the highest corporate profit years in the nation's history — those generated in 2005 and 2006 (an aggregate $3.5 trillion before taxes), he says. The $33 billion represents the total NOLs that companies will likely claim under the newest law.
The provision enables companies to take NOLs from one of the designated years, either calendar or fiscal 2008 or 2009, and apply those losses to taxable income going back as far as 2003 or 2004, respectively. That results in lower taxable income for the prior year, which allows the company to recalculate its tax bill and collect a refund from the government. The ability to "recover cash taxes" will help companies — especially those in such hard-hit sectors as retail, real estate, and manufacturing — sustain business operations and make investments during uncertain economic times, contends McMahon.
The new carryback provision is similar to the small-business provision contained in the sweeping stimulus package passed in February. The earlier law allowed companies with $15 million or less in annual revenues to extend their NOL carryback period from two years to five years. Small businesses that have already used the five-year carryback provision may take advantage of the new rule, provided they don't double-dip into NOLs from the same year. That is, if a small business has already applied NOLs from 2008 to a prior taxable year, it is only eligible to use 2009 losses under the recently passed law.
The only companies banned from taking advantage of the new law are those that accepted government bailout money, says tax expert Robert Willens, who heads an eponymous consultancy in New York. Willens explains that the five-year NOL carryback doesn't apply to corporations that allowed the government to buy company stock or warrants in exchange for cash as part of the Troubled Asset Relief Program — even if the company has since repaid the funds. "TARP beneficiaries were singled out for punishment" with regard to the extended carryback period, he adds.
There's another twist that makes this most recent carryback law different from the previous one, says David Culp, a senior manager with KPMG. That is, if a company elects to look back to the fifth taxable year, NOLs can be used to offset only 50% of the taxable income earned that year. If NOLs remain after offsetting the fifth year's income, then the company is permitted to apply the leftover NOLs to year four, three, and so on, until the offset is used up.
The fifth-year limitation, or "haircut," is likely to have been linked to congressional budget concerns regarding the cost of legislation, Darrell Poplock, a tax partner at PricewaterhouseCoopers, believes. The new carryback provision is expected to cost the U.S. Treasury $10.4 billion over 10 years, notes Poplock, a former official with the Joint Committee on Taxation, the group that calculates the revenue estimates on tax legislation for Congress. However, according to the White House, the NOL portion of the bill is fully offset by several other measures, including a delay until 2018 of a tax break for corporations that involves interest allocation, an increase in penalties for failure to file S corporation and partnership tax returns, and a temporary increase in corporate estimated tax payments due to be paid from July to September 2014.
In practical terms, the new law gives all eligible companies more tax-planning flexibility, in that they have the opportunity to apply the NOLs over five years, rather than just two. That's important, says Poplock, because the level of taxable income for any given year "interacts with other tax attributes" the company may be managing. For example, some tax credits, including foreign tax credits, may be limited if taxable income is reduced beyond a certain threshold.
The IRS has announced that it will shortly issue guidance on how to cash in on the new law. In the past, companies have collected NOL refunds in one of two ways. The quickest way has been to file a "tentative" claim with the IRS, when the agency rules that it's appropriate. (It made such a ruling in the wake of the September 11 attacks.) Such a claim typically takes six weeks to process. After a tentative claim is filed, the IRS may review the underlying facts and law to make sure the refund was properly calculated. Alternatively, a corporation could file an amended return for the earlier year, the processing of which takes longer than a tentative claim.
Any refund that exceeds $2 million is automatically reviewed by the Joint Committee on Taxation, says PwC's Poplock. And while that may seem like it could cause a delay in the refund process, that's not the case, notes Poplock, who points out that the IRS will issue refunds prior to such reviews under expedited claim procedures. "The fact that the IRS has acknowledged the need for procedural guidance within two or three days after enactment is a very good sign" that it will act quickly on the refund mechanism, adds Culp.