If your business sustains losses, you may be eligible for a net operating loss (NOL). In most cases, the NOL is carried back automatically for two years and, if not used up, forwards for up to 20 years. However, you can opt to waive the carryback and simply carry it forward through the 20-year period until you exhaust it.
Why waive?
The carryback is usually a great idea because it generates an immediate tax refund of taxes paid in the two prior years. This refund can be used by a troubled business to get back on track.
But the value of the NOL depends on the tax bracket you were in for those two prior years and what you expect your tax bracket to be in years to come. For example, say there’s a $10,000 NOL and the tax bracket in the prior years was 25%. In round numbers, the NOL would produce a tax refund of $2,500. But if you think business will be greatly improved in years to come and your tax bracket will rise to 35%, a carryforward would save you $3,500, or $1,000 more. In this scenario, if you don’t need the cash from the refund and can afford to wait, the carryforward produces greater tax savings.
How to waive?
If you decide to waive the carryback, you must follow IRS rules. The election must be made by the due date of the return for the year of the NOL (with extensions). Once made, the election is irrevocable for the year of the waiver (you can decide different treatment for NOLs arising in other years). The waiver for regular tax purposes also applies for alternative minimum tax purposes.
The election is made by attaching your own statement (there’s no IRS form or check-the-box for this, other than for C corporations) to your return. The statement must specifically say you’re waiving the carryback under Code Sec. 172(b)(3).
What if you fail to waive?
You’re usually out of luck, and this can cost you dearly. Take this recent case of a couple whose business generated a big NOL in 2005. They didn’t do the right paperwork to waive the carryback and instead applied the NOL in 2006, generating considerable tax savings. When the IRS informed them of their error, the NOL was applied to 2003, resulting in an overpayment of more than $200,000. However, it also caused them to have an underpayment for 2006, plus interest. They asked that the IRS abate the interest, but it refused, and an appellate court recently said the IRS was right. Their own actions contributed to the tax liability and the interest on it, so no abatement was allowed.
If you don’t file the waiver with an original return, there’s a limited grace period. You can still do so on an amended return filed within 6 months of the due date of the return (excluding extensions). Attach the waiver to your amended return, and write “Filed pursuant to section 301.9100-2” at the top of the statement used for your waiver.
Conclusion
If you have an NOL, work with your CPA to determine the best way to handle things. The NOL is too valuable a write-off to waste.
