By Alistair M. Nevius
One of the biggest questions surrounding net operating losses (NOLs) is when to use this potentially significant tax attribute. Once a decision is made about when an NOL will be used, it is important that it be carried back and/or forward properly. Under IRC § 172(b)(1), an NOL (in general) can be carried back two years and forward 20 years (certain special rules exist for NOLs for specified losses, resulting in NOLs that may be carried back more than two years). The general rule under section 172(b)(2) is that an NOL is used in the following order until exhausted:
* Carried back to the second preceding tax year;
* Carried back to the first preceding tax year; and
* Carried forward to the following 20 tax years.
Carrying an NOL back to the two preceding tax years may not result in its best utilization, even if the taxpayer had significant income in those years, because the income could have been taxed at lower rates due to capital gain or qualified dividends. The taxpayer may benefit in these circumstances by electing to waive the carryback period. This is an all-or-nothing election, so the taxpayer is electing either affirmatively to waive the entire carryback period or by default to use the entire carryback period. In addition, this election must be “made by the due date (including extensions of time) for filing the taxpayer’s return” and “shall be irrevocable” (IRC § 172(b)(3)). Therefore, this election should be made after weighing the benefits of carrying the NOL back to the two preceding tax years versus the expected benefits of carrying the NOL forward.
STATUTE OF LIMITATION
Individual taxpayers can carry an NOL back to the two preceding years in one of two ways. The first is by filing Form 1045, Application for Tentative Refund, within one year from the end of the year in which the NOL occurred. The taxpayer could also file Form 1040X, Amended U.S. Individual Income Tax Return.
The Form 1040X filing period is governed by section 6511. A claim for credit or refund must generally be “filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires later” (section 6511(a)). However, this period is modified in the case of a claim for credit or refund attributable to an NOL carryback; the limitation period ends three years after the due date for filing the return (including extensions) for the tax year of the NOL that results in the carryback.
Making the election under section 172(b)(3) to waive the carryback period on a timely filed return is critical. If the election is not made and the claims for credit or refund are not filed for the preceding two years within the limitation period discussed above, the taxpayer may lose out on its ability to use all or a portion of its NOL.
For a detailed discussion of the issues in this area, see “Mitigating the Results of a Failure to Carry Back an NOL,” by Robert L. Venables III, CPA, J.D., LL.M., in the August 2011 issue of The Tax Adviser.