U.S. tax relief temporarily extends loss carryback while delaying worldwide interest allocation

President Obama signed into law on 6 November 2009 the Worker, Homeownership, and Business Assistance Act of 2009, an unemployment insurance extension bill that also allows businesses with net operating losses (NOLs) for 2008 or 2009 to carry back those losses for up to five years and extends and modifies the first-time homebuyer credit.

The Act's tax relief provisions are paid for by a delay in the effective date of the worldwide interest allocation election, an increase in the corporate estimated tax payments for certain large taxpayers in the third quarter of 2014 and an increase in the penalty for failure to file a partnership or S corporation return.

This article outlines the tax provisions in the new legislation and discusses the issues that taxpayers should consider before taking advantage of the important planning opportunities it presents.


Five-year NOL carryback

The loss carryback gives cash-strapped businesses greater flexibility in writing off current losses against past profits by allowing them to carry back NOLs for up to five years (from the current law two years) for losses incurred in taxable years beginning or ending in either 2008 or 2009 – but not both. Businesses may offset 50% of taxable income in the fifth preceding year and 100% of taxable income in the remaining four carryback years. If an election is made to carry back an NOL to the fifth year preceding the loss year, the carryback is limited to 50% of taxable income. The remaining balance of the NOL generated in the loss year is carried forward to the fourth year preceding the loss year, and so on until the loss is utilized or expired.

The provision also suspends the 90% limitation on the use of any alternative tax NOL deduction attributable to carrybacks of the applicable NOL for which an extended carryback period is elected. For purposes of applying the 50% taxable income limitation to the carryback of an alternative tax NOL deduction to the fifth preceding taxable year, the limitation is applied separately based on alternative minimum taxable income.

Life insurance companies may elect to increase the current law carryback period for an applicable loss from operations from three years to four or five years. An applicable loss from operations is the taxpayer's loss from operations for any taxable year beginning or ending in either 2008 or 2009. A 50% of taxable income limitation applies to the fifth carryback year.

Unlike the carryback enacted in the American Recovery and Reinvestment Act of 2009 (ARRA), this provision is not limited to small businesses – that is, taxpayers meeting a gross receipts test. (Small businesses that have already elected to carry back 2008 losses under the ARRA are permitted to carry back losses from 2009.) The extended carryback provision is available to all taxpayers other than those specifically excluded. Generally, the provision does not apply to any taxpayer (or member of the affiliated group) in which the federal government acquired or acquires an equity interest (or warrants or other rights) pursuant to the Emergency Economic Stabilization Act of 2008. The Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation are also excluded.

A taxpayer must make the election by the extended due date for filing the return for the taxpayer's last taxable year beginning in 2009. The election, once made, is irrevocable. The provision is generally effective for NOLs arising in taxable years ending after 31 December 2007 and beginning before 1 January 2010. The modification to the alternative tax NOL deduction applies to taxable years ending after 31 December 2002. The modification with respect to operating loss deductions of life insurance companies applies to losses from operations arising in taxable years ending after 31 December 2007.

The Joint Committee on Taxation staff estimates the provision will provide USD 33.2 billion of immediate tax relief at a net cost of USD 10.4 billion over 10 years.


Taxpayer considerations

Before filing an irrevocable election to carry back a 2008 loss to 2003, 2004, 2005 or 2006, taxpayers should think about the impact of such election. Failure to consider all implications of the election could result in potentially unpleasant surprises. In particular, taxpayers should consider both the tax and financial statement impact of the NOL carryback.

Federal tax – Taxpayers should analyze current tax positions to optimize the NOL generated in 2008 or 2009 (the loss year). The NOL generated in the loss year can be optimized through an analysis of accounting methods. For 2009, both items that require an accounting method change and those that do not may be considered, while optimizing a loss in 2008 may be achieved solely through analysis of items that do not require an accounting method change.

Foreign tax credits – Multinational companies that choose to take advantage of the extended NOL carryback provision must consider the impact this decision could have on their foreign tax credits (FTCs). FTCs arising in 2005 and beyond may be carried back one year and carried forward 10 years. FTCs arising prior to 2005 were carried back two years and forward five years. However, the American Jobs Creation Act of 2004 (AJCA) extended the carryforward to 10 years for FTCs carried into taxable year 2004. As a result, a company that elects to carry back a 2008 NOL to taxable years 2003, 2004, 2005 or 2006, may reduce its FTC limitation in that year and subsequent years, displacing FTCs that were previously claimed. The displaced FTCs could affect the actual cash refund received and have an impact on the company's book earnings.

A multinational company that chooses to carry back an NOL should also consider the impact the decision will have on its ability to utilize FTCs in years subsequent to 2008. Future FTC utilization may be affected as a result of recapture accounts (overall foreign loss, separate limitation loss and overall domestic loss) resulting from the NOL utilization.

In addition to the impact of the NOL carryback on foreign tax credits, revenue offsets (discussed below) further delay implementation of the worldwide interest allocation rules.

Corporate and consolidated returns – Taxpayers should consider the potential impact of stock acquisitions or dispositions and the impact on loss limitation rules, such as U.S. Code section 382, Separate Return Limitation Year (SRLY) and Code section 172(h) Corporate Equity Reduction Transactions (CERT).

State tax – Taxpayers should understand and navigate the myriad state tax laws. Many states have their own NOL regimes and most do not provide for NOL carrybacks. It remains to be seen whether those states that do follow the federal rules will conform to the new federal five-year carryback provision or decouple from it. Due to state budgetary constraints, it seems likely that many states will not conform to the federal law change.

Financial reporting – Corporate taxpayers should be aware of how the extended carryback will affect their financial statements. Pursuant to Accounting Standards Codification Topic 740, Income Taxes, any adjustment to deferred tax liabilities and assets for the effect of a change in tax laws or rates is included in income from continuing operations for the period that includes the enactment date. The enactment date of U.S. federal tax legislation is the date the president signs the tax bill into law.

Taxpayers that intend to carry back their NOLs beyond the two-year "normal" carryback period should consider:

- The necessity of an adjustment to an existing valuation allowance to take into account the additional carryback capacity is necessary (if the loss to be carried back was not previously benefited and instead the related deferred tax asset was offset by a valuation allowance, an adjustment to that valuation allowance will be necessary); and
- The appropriate financial statement disclosures (not just for the period of enactment, but also in periods prior to enactment as part of the discussion of the potential effects on the company of proposed legislation).

As this would be a change in tax law, any required adjustment to the valuation allowance will be included in income from
continuing operations in the period that includes the enactment date.


Revenue offsets

Delayed effective date of worldwide interest allocation election – The Act further delays the implementation of the worldwide interest allocation election, making it effective for taxable years beginning after 31 December 2017. The election, enacted as part of the AJCA, would permit taxpayers to take advantage of a liberalized rule for allocating interest expense between U.S. and foreign sources for purposes of determining their foreign tax credit limitation. As enacted in the AJCA, the provision was scheduled to take effect for taxable years beginning after 31 December 2008, but was delayed for two years by the Housing and Economic Recovery Act of 2008.

The Act also eliminates a special phase-in rule enacted under the AJCA that would reduce the amount of the benefit in the first year of the election.

Corporate estimated tax payments – The Act increases the required corporate estimated tax payments factor for corporations with assets of at least USD 1 billion by 33 percentage points for payments due in the third quarter of 2014.

Corporate estimated tax payments are reduced by a corresponding margin in the following quarter.

Higher penalties for failure to file partnership and S corporation returns – The Act increases the base penalty applied to partnership or S corporation returns for failure to file a return to USD 195 per shareholder or partner. The penalty applies for each month (or fraction of a month) that the failure continues, up to a maximum of 12 months for returns required to be filed after 31 December 2008. The higher penalty will apply to returns for taxable years beginning after 31 December 2009.

Other revenue offsets – The Act extends the 0.2% FUTA surtax through 30 June 2011 and reduces the tax authorities' operating costs for returns filed after 31 December 2010. The Act also requires that tax return preparers electronically file individual, estate and trust returns they prepare unless they reasonably expect to prepare 10 or fewer returns during the calendar year.