Has your business had> a rough year? The new Worker, Homeownership, and Business Assistance Act of 2009 (signed into law on Nov. 6) gives an important break to businesses that incur tax losses. In tax lingo, these are called net operating losses, or NOLs.
Under the general rule, an NOL can be carried back for two years and deducted against taxable income in those years. Depending on the size of the NOL, you ll then get a refund for some or all of the taxes paid for those years.
Obviously, when cash is tight, these refunds can be a lifesaver. But it would be even better if you could carry back an NOL to recover taxes paid three, four or five years ago. The new law allows you to do just that, with a twist for the fifth year. Here s what you need to know.
How the Extended Carryback Rule Works for Small-Business Losses
The new law s extended NOL carryback deal applies to large and small businesses alike. However, for smaller outfits the new break is layered on top of a similar break that was included in February s Stimulus Act. Under the Stimulus Act provision, you could carry back a 2008 NOL for three, four, or five years (instead of the normal two years), but only if that NOL was from a business with average annual gross receipts of no more than $15 million. So if your small business had a 2008 NOL, you could choose to carry it back as far as 2003 and recover some or all of the federal income taxes paid for that year. If you still had some NOL left, you could deduct the remaining amount against your 2004 income, then against your 2005 income, and so on until the NOL was all used up. And if you still had some 2008 NOL left after all these carrybacks, you could carry that amount forward for 20 years to offset taxable income in 2009 and beyond.
Under the new law, you can choose to carry back either a 2008 or 2009 NOL for three, four or five years. If you already took advantage of the Stimulus Act break to carry back a 2008 NOL for more than two years, the new law allows you to do the same thing for a 2009 NOL. However under the new deal, an NOL carried back to the fifth preceding year can t be used to offset more than 50% of that year s income. This is pretty confusing, so here are some examples.
Example 1: Say your business generated a $100,000 NOL in 2008 which you chose to carry all the way back to 2003 (the fifth year before 2008). You used up the entire NOL to offset 2003 income and got a big tax refund. Now it looks like your business will run up another $100,000 NOL for 2009. Under the new law, you can choose to carry this year s NOL back as far as 2004 (the fifth year before 2009). Say your 2004 taxable income was $80,000. Under the 50% limitation, you can use the NOL carryback to wipe out $40,000 of 2004 income (50% of $80,000). You can then use the remaining $60,000 of NOL to offset income from 2005-2008 (there s no 50% limitation for carrybacks to those years).
Example 2: Say your business got through 2008 without running up a loss, but you ll have a $100,000 NOL for 2009. Under the new law, you can choose to carry that NOL as far back as 2004 (the fifth year before 2009). Say your 2004 taxable income was $120,000. Under the 50% limitation, you can use the NOL carryback to wipe out $60,000 of 2004 income (50% of $120,000). You can then use the remaining $40,000 of NOL to offset income from 2005-2008 (there s no 50% limitation for carrybacks to those years).
You Have Options
While the new law allows you to carry back a 2009 NOL for up to five years, you don t have to go that far back. As I said earlier, you can also choose to carry back a 2009 NOL for four years or three years. Or you can follow the standard rule and carry it back for two years. Or you can choose to carry the entire 2009 NOL forward for 20 years. All things being equal, you want to use the NOL to offset income in years when you pay the highest taxes. (However, cash flow considerations may dictate carrying back the NOL as far as you can.)
Bottom Line: If you ll have a significant 2009 NOL to play with, huddle up with your tax pro before deciding what to do. If you choose to take advantage of the new law s extended NOL carryback option, the deadline for making that choice is the due date for your 2009 return. (Don t make that choice lightly: Once it s made, it s irrevocable.)
Since the 2009 tax year is still running, you might actually want to take actions between now and yearend that would create or increase an NOL that you could then carry back to prior years to collect tax refunds. For more on that idea, see Tax Breaks for Losses on Rental Property Sales and Clock Is Ticking on These Small Biz Tax Perks (on how to claim bonus depreciation deductions for purchased equipment and software).