Morgan Miller Blair

Today, President Obama signed the Worker, Homeownership and Business Assistance Act of 2009 which significantly expands the ability of companies to generate a tax refund by taking losses incurred in 2008 or 2009 and applying them against taxes paid in the prior five years.  The homebuilding industry lobbied heavily for this bill as it is expected to generate a wave of transactions for homebuilders.  However, it also will apply to other businesses in need of crucial cash infusions.

The bill represents the second expansion of the net operating loss (NOL) carryback this year.  Historically, businesses could carry back most losses from the current year up to two years and obtain a refund of taxes paid in those years.  The first expansion came in the American Recovery and Reinvestment Act, commonly known as the “stimulus bill”, which extended the NOL carryback for certain small businesses to five years but only for losses incurred in 2008.  The bill signed today extends the five year NOL carryback to almost all businesses regardless of size and includes losses incurred in either 2008 or 2009. To be clear, a taxpayer with losses in both 2008 and 2009 cannot carryback the losses from both years; generally, the taxpayer has to elect only one loss year to carryback.

Eligible taxpayers can offset 2008 or 2009 operating losses against 100% of taxable income reported in years one through four and against 50% of income in year five. Small businesses with less than $15 million in average gross receipts would be able to claim a five-year carryback for 2008 losses under the stimulus bill and for 2009 losses under the new law.  These small businesses are also eligible for some relief from the 50% income limitation for year five carrybacks and may be able elect carryback for both 2008 and 2009 losses.

The bill could generate a wave of transactions in the homebuilding industry as sellers look to shed underperforming assets to obtain a tax refund on the loss and opportunistic buyers seek to profit by purchasing from the motivated sellers. This would impact merchant builders and other sellers holding real property for sale, as opposed to investment. The sale of investment property at a loss will generally be capital losses and not operating losses. The bill creates a planning opportunity, but will require quick action. In order for any deal to generate a loss in 2009, it would have to be completed by the end of the taxpayer’s 2009 year end.  Any ordinary income asset which can be sold at a loss by a seller that paid taxes in the prior five years may benefit from the new tax treatment.  The tax year of the seller must be factored in to any transaction undertaken in 2009. For a fiscal year taxpayer, eligible losses are those incurred on a fiscal year basis. Thus, if the seller’s tax year ends on October 31 or prior, it would not be able to engage in a transaction that would generate a 2009 loss. If the seller’s tax year ends on November 30, then the parties would have to close their transaction on or before that date.

Beyond homebuilders, the expanded NOL carryback provisions will also benefit businesses in all sectors of the American economy, such as manufacturers, service providers and technology companies that reported losses in 2008 or will experience them in 2009 because operating expenses exceeded revenue as a result of the recession or other circumstances. To the extent those businesses were profitable during the prior five years, the bill should provide an opportunity to obtain a tax refund that may represent much-needed working capital in this challenging financing environment.

As with all tax breaks, certain limitations apply.  The provisions are not applicable to any institution which received TARP funds or to Fannie Mae or Freddie Mac.  The bill authorizes the Secretary of Treasury to prescribe rules to prevent the abuse of the NOL carrybacks, including rules regarding anti-stuffing, anti-churning and wash sales. 

If you need any assistance in these matters, please contact Chris Hunter, George Cabot or Bruce Ring.