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 repeal of the net operating loss carryback. There is even some enhancement of the net operating loss 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 net operating loss as a carryforward in that such loss couldn’t decrease income by more than 90%.
While net operating losses could be carried forward, they couldn’t be carried back.
The unfairness of eliminating the net operating loss carryback isn’t getting enough discussion.
Current rules generally allow an NOL to carry back two years, three years in the case of a “small business.” Section 172. The net operating loss deduction as a carryover and carryback has a very long history. The net operating loss deduction as a carryback has some history as early as our World War I 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 one million in tax losses in year one and one million in profits in year two and break even taxwise over two years because the earlier losses would carry forward. But reverse the order and have the income before the losses, 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. But in this CPA’s view, it would do so unfairly.
We need to keep in mind reasonableness and fairness. 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 net operating loss carryback should be opposed because it is fundamentally unfair.
Businesses, the real estate industry and the fair-minded generally should understand the need to vigorously oppose this little-discussed aspect of the Ryan proposals. The time for speaking up on this is now.
