The changes being discussed are of such a magnitude that many taxpayers are filing extensions while their advisers ponder how 2016 tax elections may affect 2017.
We focus here on one major provision that seems to be getting only a minor amount of attention.
An important revenue raiser for the government in House Speaker Paul Ryan’s 2016 proposals is the repeal of the net operating loss (NOL) carryback. There is even some enhancement of the NOL as a carryforward—the ability to carry losses forward indefinitely with an increase in the actual loss for an interest factor. There is a new restriction on the NOL as a carryforward in that such a loss couldn’t decrease income by more than 90 percent.
While NOLs could be carried forward, they couldn’t be carried back.
The unfairness of eliminating the NOL carryback isn’t getting enough discussion. Current rules generally allow an NOL to carry back two years, or three years in the case of a “small business.” The NOL deduction as a carryover and carryback has a very long history. The NOL deduction as a carryback has some history as early as the WWI era.
The concept of carrying back or forward losses helps equalize the tax treatment of businesses with constant income and those with fluctuating income.
A taxpayer starting out might have $1 million in tax losses in year one and $1 million in profits in year two and break even tax-wise over two years because the earlier losses would carry forward. But reverse the order and have the income before the losses, and this taxpayer would pay taxes on $1 million despite having no income over the cumulative two-year period. The latter would have only the contingent benefit of using the loss carryforward against future income.
Some industries, such as real estate, may be affected more than others. Old businesses starting new product lines or expanding into new territories may be discouraged.
The annual accounting concept is a cornerstone of our tax system, but it can yield harsh results, particularly if the concept isn’t mitigated by allowing the losses of one year to carry back to recover taxes paid in an earlier year.
The context of Ryan’s proposal is one of major tax rate reductions, so one of the topics for policy discussions is whether to allow the losses in low rate years to carry back to recover taxes in high rate years. Yet such anomalies are inherent in rate changes, and the repeal of the ability to carry back operating losses seems couched in simply raising revenue. In this CPA’s view, it would do so unfairly.
Businesses occasionally need the ability to offset the losses of one year against another, and the order of the losses and income shouldn’t yield radical differences. Eliminating the NOL carryback should be opposed because it is fundamentally unfair.
The business community and the real estate industry should understand the need to vigorously oppose this little-discussed aspect of the Ryan proposals. The time for speaking up on this is now.
Robert L. Rojas, CPA, is the owner of Los Angeles-based accounting firm Rojas & Associates.