Net Operating Loss: Paying It Forward

Can a company use a net operating loss to diminish future tax returns even though the period for filing a claim has expired?
Robert WillensJanuary 17, 2012

A corporation can increase its net operating losses (NOLs) by claiming additional deductions even though the deductions arose in a year that was closed by a statute of limitations, according to a recent Internal Revenue Service ruling.

In the case at hand, the corporate taxpayer (TP) contended that its interest deductions on its tax returns for two consecutive years were limited by Section 163(j) of the Internal Revenue Code. The branch of the IRS that administers large business and international taxpayers (LB&I), argued that Section 163(j) does not apply and thus TP’s interest deductions for the two years are larger than the amounts reported by TP.

LB&I asked whether the increased interest deductions would allow TP to increase its NOL for those years “even if the statutory period for filing a claim for credit or refund has expired for those years.” In a decision issued September 13, 2011, the IRS answered yes.

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Under the tax code, a taxpayer’s NOL is the excess of its deductions over its gross income. Once a taxpayer determines the amount of its NOL, the NOL is carried back or carried over in accordance with rules that generally require that an NOL for any taxable year first be carried back to each of the two preceding taxable years. To the extent that part of the NOL is still available, it can be carried forward to each of the 20 taxable years following the taxable year of the loss.

After an NOL is carried back or carried over, the taxpayer must determine the amount of the NOL that was absorbed in the carryback or carryover year. The code provides that the portion of the NOL carried to each taxable year is the excess of the amount of the NOL over the sum of the taxable income (with certain modifications) for each of the prior taxable years to which the loss may be carried.

Another passage of the code provides that a claim for credit or refund of an overpayment of tax must be filed by the later of three years from the time the return was filed or two years from the time the tax was paid. A credit or refund is not allowed unless a claim is made within this period.

There is, however, a special period of limitation for NOL carrybacks. A taxpayer generally has three years from the time prescribed by law for the filing of the return for the taxable year of the NOL to file a claim for credit or refund if it relates to an overpayment attributable to an NOL carryback.

In the case under consideration, an increase in TP’s interest deductions for the two years in question would result in a corresponding increase to its NOLs for those years.

Because the two years are “closed” years, TP cannot get a refund of taxes paid then, and cannot use its NOL for those years, as increased, to get a refund for the offset of income in a carryback year. However, TP would be allowed to use its NOL in an “open” carryover year provided that the company can establish that the NOL was not absorbed by its taxable income in the carryback years or any prior carryover years. The IRS ruled that TP could show that its NOL was not absorbed in those prior and overlapping years, and hence it could carry the loss forward.

Robert Willens, founder and principal of Robert Willens LLC, writes a tax column for