Net Op Loss? New tax rule benefits small businesses

The turbulent economy is one of the most talked about issues today and one of the most predominant issues facing us in the future. Efforts toward turnaround and growth involve many initiatives. Among them? The American Recovery and Reinvestment Act of 2009. As part of this tax legislation, Congress has included a temporary provision for certain small businesses to use a longer carryback period for net operating losses (NOLs) incurred in 2008.

Normally, the NOL can be carried back two years and forward 20. This normal two-year period may now be extended back as many as five years. Also new with this provision is an option to select a three-, four- or five-year carryback period. The normal rules require a fixed carryback period, and have not previously provided this flexibility.

How can a flexible carryback help you? Depending on the historical income and losses of your particular business, the longer carryback period may bring in to play "income years" that would have been otherwise unavailable under the normal two-year rule. In addition, with the ability to choose the length of your carryback period, you may be able to maximize refunds by electing a year when taxes were paid at a higher marginal rate. Using this extended carryback period may also leave other years available for potential refunds should your business incur another loss in 2009 or beyond.

Who's Eligible?

Businesses with three-year (2006-2008) average-gross receipts of $15 million or less will be eligible for this provision. This includes corporations, partnerships and sole proprietorships. In the case of a pass-through entity, such as an S-corporation or partnership, the gross receipts test is determined at the entity level. However, the NOL election must be made by the shareholder or partner on his or her individual returns.

Another benefit to look forward to: a favorable increase in the 2008 and 2009 Section 179 deduction, plus a 50-percent bonus depreciation deduction for new assets in service in these years.

It appears that congress intends to allow individual taxpayers to maximize tax benefits under the new NOL rules as well. Pending legislation has been introduced in the Senate that would extend to NOLs generated in 2009 and also would include all taxpayers, rather than small businesses only.

Take Action

In order to take advantage of the current 2008 NOL provision, eligible taxpayers must affirmatively elect the increased carryback period. Without this election the regular NOL rules will apply. Calendar-year filers can elect for their 2008 tax year; fiscal-year filers can elect for either their tax year beginning or ending in 2008-but not both.

The election can be made on an original return filed on time (extensions included). It can be made on an amended 2008 return as well, provided: a) the taxpayer did not elect to waive the carryback on the original return, and, b) the amended return is filed by the "later of" six months after the original due date (without extensions) or April 17, 2009. If the taxpayer elected to waive the carryback period on the original 2008 return, any change to that election would require completion by April 17, 2009.

Critical Caveats

If there's been a change in marital status, business ownership or form of entity, you can expect various complexities with regard to the allowable carryback. Other items affected by the NOL carryback include the Alternative Minimum Tax, taxable social security benefits, AGI-based phaseouts and deductions, passive activity NOLs, basis limitations, state NOLs, among other things. Not only are these affected in the carryback year but also for intervening years as remaining NOLs are carried forward.

Your tax advisor can assist in working through these and help determine any remaining opportunity to turn 2008 losses into current cash refunds. Your 2009 business activity should also be considered, in light of pending legislation, in order to make the best use of your deductions and maximize tax benefits.

Shelly A. Ashmore, CPA, MST is a tax manager at Dennis, Gartland & Niergarth in Traverse City, where she specializes in mergers, acquisitions and partnership taxation.