The past few years have witnessed significant economic downturn in virtually all business areas. This downturn has produced significant operating and capital losses for many businesses. Many business owners and their accountants have historically carried forward such losses on tax returns. A gloomy economic forecast has focused interest on little used tax provisions regarding loss carrybacks. Sections 1212 and 172 of the Internal Revenue Code (“IRC”) permit taxpayers to “carryback” losses for prior tax years. Depending upon the applicable IRC section and the nature of the taxpayer, as a general rule, those losses may be carried back for up to three (3) prior tax years; however, a little known change in the IRC this past year permits net operating loss carrybacks for any taxable year ending during 2001 or 2002 to extend back five (5) years. There are specific limitations regarding the use of loss carrybacks and loss carrybacks are not available to all taxpayers. In addition, there are different rules for individual and corporate taxpayers and distinct rules depending upon the nature of the loss (i.e., capital or operating). For example, a capital loss can be used in certain instances to offset net operating income, but may not be used to increase or produce a net operating loss.
Section 1212 of the IRC governs capital loss carrybacks and carryovers for corporations. If a corporation has a net capital loss for any taxable year (the “loss year”), it first becomes a capital loss carryback to each of the three (3) taxable years preceding the loss year and then becomes a capital loss carryover to each of the five (5) taxable years succeeding the loss year. In determining the net capital loss of a particular year, there is not included a net capital loss carryover from another year. The carryback is treated as a short-term capital loss in the year to which it is carried, regardless of the nature of the capital loss from which it is derived. The loss is first carried back to the earliest of the permitted taxable years, and then is carried in sequence to each subsequent permissible year to the extent of the excess of the loss over the capital gain net income of all prior years to which the loss may be carried. Where the carryback is barred in whole or in part because it produces or increases a net operating loss in the prior year, the capital gain net income of that year is not to be treated as greater than the amount of the loss that can be carried back to such preceding taxable year.
Section 172 of the IRC governs net operating loss carrybacks and carryovers. As a general rule, the net operating loss for any taxable year is to be carried back to each of the two (2) taxable years preceding the taxable year of loss, and then carried over to each of the twenty (20) taxable years following the taxable year of loss. A three (3) year carryback period instead of a two (2) year carryback period is allowed for “eligible losses.” However, in the case of a taxpayer which has a net operating loss for any taxable year ending during 2001 or 2002, a five (5) year carryback period is allowed, regardless of whether the loss is an eligible loss. Net operating losses are to be carried back, first, to the earliest of the taxable years to which they may be carried, and then chronologically through the succeeding prior taxable years. Thereafter, net operating losses are to be carried over to the taxable year following the year in which the loss was incurred, and then, chronologically, to each of the future years into which the loss may be carried. In this way, the net operating loss for a loss year is successively offset against or absorbed by the taxable income for the years to which the net operating loss may be carried back or carried over, until it is offset or absorbed entirely. The taxable income of any year to which a net operating loss may be carried back or carried over is to be adjusted in certain respects. The taxable income for such years available for carryback or carryover, however, is not to be treated as less than zero. A taxpayer may elect to forego altogether the carryback of net operating losses, and instead take only the applicable carryover. The election is irrevocable for the taxable year for which it is made but is not applicable to other years unless another election is made.
Prudent business owners may want to reexamine their use of losses, especially for years 2001 and 2002, and file amended tax returns, if available. To discuss these matters further, please call.