Federal legislation regarding net operating losses and the impact on taxpayers

A net operating loss is the amount by which business deductions exceed gross income (with modifications). Real estate professionals (those individuals not subject to limitations on the deduction of losses from real estate operations under the passive activity rules) may incur net operating losses if their losses from real estate operations exceed their other income. It is also possible for an individual or closely held corporation to realize a net operating loss where, for instance, a loss is recognized on the disposition of a former passive activity that had passive activity loss carryovers at the time of disposition. Taxpayers that sustain a net operating loss for a tax year generally can use net operating loss to reduce income in another tax year. Under the general rules that existed prior to 2009, taxpayers must carry a net operating loss back to each of the two tax years preceding the loss year. Any remaining net operating losses after carryback is carried forward over to each of the 20 tax years following the loss year. Alternatively, an election is available to forego the carryback period and only carry the net operating loss forward instead. The American Recovery and Reinvestment Act (ARRA) of 2009 extended the general carryback period for 2008 net operating losses from two years to up to five for eligible small businesses. An eligible small business is defined as a corporation or partnership that meets a $15 million gross receipts test for the tax year in which the loss arose. On November 6, 2009 President Obama signed the Worker, Homeownership, and Business Assistance Act of 2009 (the Act), which expands the ARRA. The Act includes a provision that permits most companies, regardless of size, to carry back certain 2008 or 2009 net operating losses up to five years. The Act generally permits individuals, estates and trusts, exempt organizations with unrelated business income, and corporations, regardless of size, to elect to carry back "applicable net operating losses" three, four, or five years. An "applicable net operating loss" is a net operating loss that arises in a tax year either beginning or ending in 2008 or 2009. In the case of an election to carry back the applicable net operating loss to the fifth preceding year, the amount of the net operating loss carryback that may be applied in that fifth carryback year is limited to 50% of taxable income of that fifth preceding year. Any excess net operating loss not eligible for carryback to the fifth preceding year due to this limitation may be carried forward to the fourth preceding year and so forth. The Act also eliminates, for applicable net operating losses, the rule that restricted the alternative minimum tax (AMT) net operating loss deduction to not more than 90% of AMT income. Revenue Procedure 2009-52 provides guidance on when and how to elect an extended carryback period. Taxpayers may make the election on either (1) a federal income tax return for the tax year of the applicable net operating loss or (2) a carryback application or claim (Form 1045 for individuals, Form 1139 for corporations). According to the Revenue Procedure, the statement evidencing the election must: * State that the taxpayer is electing to apply Section 172(b)(1)(H) under Revenue Procedure 2009-52; * State that the taxpayer is not a TARP recipient nor in 2008 or 2009, an affiliate of a TARP recipient; * Specify the length of the NOL carryback period elected (3,4 or 5 years); * When applicable, state that the election amends a previous application or claim; or * When applicable, state that the taxpayer is revoking an NOL carryback waiver. Pursuant to Revenue Procedure 2009-52, a taxpayer must file the election statement with the taxpayer's original or amended federal income tax return for the taxable year of the applicable net operating loss on or before the due date (including extensions) for filing the return for the taxpayer's taxable year beginning in 2009 (e.g. September 15, 2010 for a calendar year corporation that timely filed an extension). For a taxpayer that makes the Section 172(b)(1)(H) election in this manner, the revenue procedure also extends the due date for timely filing Form 1045 or Form 1139 to this same date. The discussion above relates only to net operating losses for federal income tax purposes. State law with respect to net operating losses varies by state and is beyond the scope of this article. Sandy Klein, CPA, is a partner at Shanholt Glassman Klein Kramer & Co., New York, N.Y.