The past two years haven't been kind to many businesses. If yours is one of them, the good news is that you may be eligible for a refund from the Internal Revenue Service because of the tax you paid on a prior year's profit.
Nearly every taxpayer is permitted to take a net operating loss (NOL) from a business and "carry it back" as a deduction against a previous year's income. On the other hand, if your business lost money a few years ago and now shows a profit, you may be eligible for a carry forward - applying the loss against your current income to lower your current taxes.
Keep in mind that an NOL equals gross income minus deductions based on the tax code for the year when the loss was incurred. Because the tax code changes nearly every year, it's important to check the rules in effect at the time.
Taxpayers entitled to the carry-back and carry-forward privileges include corporations, individuals, estates, trusts, and partners who may deduct allocable partnership loss. The benefit of an NOL deduction does not apply to a partnership, only to its individual partners.
The carry back of an NOL usually results in a refund for income tax paid during the carry-back year. A carry forward reduces federal income tax for the carry-forward (current or future) year.
In general, an NOL may be carried back two years and carried forward 20 years. A three-year carry back applies only for NOLs arising from casualty or theft losses to individuals, or for NOLs attributable to federally declared disasters such as hurricanes or floods. That means, for most businesses, a loss in 2003 can carry back to offset profits only for 2002 and 2001. But what if you lost money those years also? You cannot apply your NOL to the previous years. Instead, keep the NOL in your back pocket as a carry forward. When business picks up during the next two decades, you can use the NOL to lower your future tax bill.
You can also split a loss into carry-back and carry-forward portions. Suppose your business had a profit of $50,000 last year, but this year had an NOL of $70,000. You could apply $50,000 of the loss to neutralize last year's tax liability, while keeping the other $20,000 to offset future earnings.
In terms of paperwork, if you are a sole proprietor or partner, you should list all carry backs and carry forwards on Form 1045 (Application for Tentative Refund). Form 1045, however, may be used only if filed within one year after the close of the NOL year.
As an alternative to Form 1045, an individual may file an amended tax return using Form 1040X for each carry-back year to claim a refund. Form 1040X must generally be filed within three years after the due date of the return for the NOL year. You must still attach the NOL computations using the Form 1045 computation schedules.
Corporations (other than S corporations) may file for a quick refund using Form 1139 (Corporation Application for a Quick Refund). Form 1139 must be filed within one year after the close of the NOL year. A separate Form 1120X (Amended Corporate Tax Return) may be filed in place of Form 1139 for each carry-back year, generally within three years after the due date of the return for the NOL year.
If your business is incorporated and you expect a net operating loss carry back from the current (unfinished) tax year, you can, subject to certain limitations, extend the time for payment of all or part of the tax still payable for the immediately preceding year. To do so, file Form 1138 (Extension of Time for Payment of Taxes by a Corporation Expecting a Net Operating Loss Carry Back). The extension applies only to payments of taxes that are required to be paid after Form 1138 has been filed.
When using a carry back or carry forward, be mindful that if your Form 1039 or 1045 is audited, you will be expected to document your NOL. Not surprisingly, the IRS scrutinizes these forms carefully.
Milton Zall, president of the editorial consulting firm Zall Enterprises in Silver Spring, Maryland, specializes in tax, investment, and human-resources issues.
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