Mitigating the results of a failure to carry back an NOL.

• Author: Bakale, Anthony S.
• Position: Net operating loss

Net operating loss (NOL) is a topic that clients and tax professionals often discuss. One of the biggest questions surrounding an NOL is when to use this potentially significant tax attribute. Once a taxpayer makes a decision about when to use an NOL, it is important that it be carried back and/or forward properly.

Background

Under Sec. 172(b) (1), an NOL (in general) can be carried back 2 years and forward 20 years (certain special rules exist for NOLs for specified losses, resulting in NOLs that may be carried back more than 2 years). The general rule under Sec. 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 making the election provided in Sec. 172(b)(3) 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" (Sec. 172(b) (3)). Therefore, a taxpayer should make this election only 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 for NOL Carryback Claims

A taxpayer that is an individual 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. For example, an individual taxpayer whose tax year ends on December 31 has until the following December 31 to file Form 1045. The taxpayer could also file Form 1040X, Amended U.S. Individual Income Tax Return.

Sec. 6511 governs the period in which a taxpayer can file Form 1040X. 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" (Sec. 6511(a)). The statute of limitation found in Sec. 6511(a) is modified in the case of a claim for credit or refund attributable to an NOL carryback. Sec. 6511(d) (2) (A) provides that

[i]f the claim for credit or refund relates to an overpayment attributable to a net operating loss carryback or a capital loss carryback, in lieu of the 3-year period of limitation prescribed in subsection (a), the period shall be that period which ends 3 years after the time prescribed by law for filing the return (including extensions thereof) for the taxable year of the net operating loss or net capital loss which results in such carryback, or the period prescribed in subsection (c) in respect of such taxable year, whichever expires later. Therefore, taxpayers have at least three years from the date they filed the return that generated the NOL to file a claim for credit or refund to carry the NOL back to the two preceding tax years. The statute of limitation found in Secs 6511(a) and (d) (2) (A) can be illustrated

by the following examples:

Example 1: X, an individual, calendar-year taxpayer, filed his 2009 Form 1040 on April 15, 2010. If X's 2009 return fails to include a deduction for educator expenses, assuming that he otherwise qualifies for the deduction, X will have until April 15, 2013, to amend this return under Sec. 6511(a). Example 2: The facts arc the same as in Example 1, except that X wishes to amend his 2009 return to...