Question

The Internal Revenue Code allows a corporation to carry back or carry forward an “operating loss” for a given year.

• In your own words define an operating loss carryback and a carryforward explaining the conceptual questions that surround these issues.

Answer 1

When a business operates operating expenses on its tax return that exceed its revenues,a net operating loss(NOL) has been created.An NOL can be used in some other tax reporting period as an offset to taxable income,which reduces the tax liability of the reporting entity.

Basic rules for using an NOL are:

1.Carry the amount back to the preceding two tax years and apply it against any taxable income,which can generate an immediate tax rebate.You can waive the action and instead proceed directly to the next step;if so,attached a statement to your tax return int he year in which the NOL was generated,documenting the waiver.

2.Carry the amount forward for the next 20 years and apply it against any taxable income,which reduces the amount of taxable income in those years.

3.After 20 years,any remaining NOL is cancelled.

It makes sense financial sense to apply the NOL against the earliest periods possible,since the time value of money concept dictates that the tax savings in these periods is more valuable than for any tax savings in later periods.

If NOL are being generated in multiple years,use them in order the NOL'S were generated.This means the earliest NOL should be completely drawn down before the next oldest NOL is accessed.This approach reduces the risk that an NOL will be terminated by the 20 yrs rule noted earlier.

LIMITATIONS (sec 382):

Internal Revenue Code sec 383 states that:

1.If there is at least 50% ownership change in a business that has an NOL,

2.The acquirer can only use that portion of the NOL in each successive years that is based on the long-term-exempt bond rate multiplied by the stock of the acquired entity.

Sec 382 can create a significant problem when a business has large unused NOLS on its books.

EXAMPLE 1:

Company Z has following information-

Taxable Income-$500,000

Tax Deductions-$700,000

Corporate Tax Rate-30%

Calculation Of Net Operating Loss(NOL)-Taxable Income-Tax Deductions

- $(500,000-700,000)

= -$200,000

Net Operating Loss= -$200,000

Because Company Z does not have taxable income,it does not pay taxes that year.

Otherwise it would have paid tax :

$250,000x30% = $ 75,000 tax

Because the company had an NOL the previous year,it may put the NOL toward the current year's tax bill,reducing it significantly(or even to $0,depending on the jurisdiction company Z is in) or apply it against taxable income in previous years.

EXAMPLE 2:

Huntsman Corporation in 2009,the year that the Great Recession took hold, recorded an operating loss of over $71 million.That year Gross Profit was $1068 million.

Operating expenses $ 1139 million comprise :

• Selling,general and administration(SG&A)
• Research and Development(R&D)
• Restructuring
• Impairment and Plant costs

Leaving the Chemical maker with an operating loss.

The last expense line item was $ 152million.

Such expenses in most cases are considered non-recurring,which means that a normalized operating income/loss number would exclude the charge.Instead of the operating loss,then,an "adjusted"result would be an operating profit of $ 81 million.