Monetizing your losses Featured

7:00pm EDT February 23, 2010

Weak business conditions and a tight credit market have left many business taxpayers cash strapped. And many of those taxpayers have incurred business operating losses.

However, last November’s changes to the Internal Revenue Code relating to the tax benefits of such losses will result in significant dollars being put back into the hands of many taxpayers. The Worker, Homeownership and Business Assistance Act of 2009 is expected to benefit businesses by more than $33 billion in 2010, says Steven Y. Patler, JD, CPA, and a senior manager at Cendrowski Selecky PC.

“Companies that avail themselves of these changes in the law and that mine the existing provisions of the Internal Revenue Code may now be able to survive the rocky economy unscathed,” Patler says.

Smart Business spoke with Patler about how taxpayers can best position themselves for obtaining tax refunds from the government this year.

How do the new loss rules work?

If taxpayers had business operating losses in 2008 and/or 2009, they may have the opportunity to carry some or all of their losses back for up to five years to offset taxable income. Consequently, all or a part of the taxes paid during those prior five years may be refunded to the taxpayer.

Taxpayers have the ability to choose a carryback period of between two and five years. This is a change from prior law in which taxpayers were generally limited to carrying such losses back only two years. If a taxpayer elects to go back five years, there are additional income limitations that may apply in the fifth year.

Although there are no restrictions as to the size of a business eligible to take these losses, a taxpayer may only make the election to carry back losses beyond two years once, either in 2008 or 2009, unless the business meets the requirements of an eligible small business ($15 million or less in gross receipts). So it may be possible for an eligible small business to carry losses incurred in both 2008 and 2009 back five years.

The new rules apply to corporations as well as to individuals who may have net operating losses through self-employment or through a pass-through entity, such as an S corporation or partnership. Taxpayers receiving TARP money are not eligible for the liberalized carryback rules.

To obtain the largest refund possible under the law, a taxpayer must do some substantial planning. One must select the proper year to elect carryback, decide which years to carry back the losses to and determine the actual amount of the loss.

For some taxpayers, it may, in fact, not be beneficial to carry back losses to prior years and to use their losses in future years by irrevocably electing to relinquish a loss carryback. Every taxpayer’s situation is different, and generalizations cannot be made.

Is there an expedited procedure to obtain a refund due to a net operating loss?

Yes. Both individuals and corporations with losses that can be carried back can file an application for tentative refund. The advantage of filing for a tentative refund is that the funds are usually available within 45 days.

A normal refund request is subject to IRS examination prior to payment; if the refund is in excess of $2 million, it is subject to further review by the Joint Committee on Taxation.

It is important that the relevant forms be prepared without material errors or omissions to avoid rejection. This quick refund application must be filed after the tax return is filed for the year of the loss. Typically, the quick refund application must be filed within 12 months after the last day of the loss year, but the new law is permitting additional time for certain taxpayers.

Another related provision of the Internal Revenue Code permits a corporation expecting a net operating loss in the current year to postpone paying all or some of its income tax liability from the immediately preceding year by filing a Form 1138.

Are there other tax-related opportunities for taxpayers to improve cash flow?

Yes. Taxpayers can enhance cash flow by reviewing accounting methods to accelerate deductions and defer income, examining business activity to identify ordinary loss opportunities, adjusting current estimated tax payments, identifying federal and state tax credits, and applying for a quick refund of corporate estimated tax overpayments.

How can a company obtain a quick refund of estimated tax?

A corporation that has overpaid its estimated tax throughout the year does not have to wait until it files its income tax return to get back the overpayment. A corporation would need to file a form for a quick refund of overpaid estimated tax by the 15th day of the third month after the end of the tax year.

For example, a calendar-year corporation must file by March 15, 2010, for a quick refund relating to 2009 estimated payments.

It is important to note that this rule applies only to corporations, not individuals, and the overpayment must be greater than 10 percent of the revised expected tax liability. The IRS must act with 45 days of filing unless the form is filed with errors or omissions.

Steven Y. Patler, JD, CPA, is a senior manager at Cendrowski Selecky PC. Reach him at (248) 540-5760 or spatler@cendsel.com.