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Bad Year Has Tax Benefits for C Corporations

Question: My business operates as a C corporation for income tax purposes. With the economic downturn underway, are there tax considerations I should be aware of?

Yes, there are several tax considerations you should be aware of. If you expect the corporation to report a net operating loss for the year, and you paid taxes in the past one or two years, be aware that federal income tax law allows net operating losses to be carried back two years, thus enabling the corporation to recover taxes paid in those years. For example, assume a calendar year C corporation paid federal income tax of $340,000 for the calendar year ended December 31, 2006 on taxable income of $1,000,000 and paid $255,000 of federal income tax for the calendar year ended December 31, 2007 on taxable income of $750,000. In 2008, the corporation computes a net operating loss of $2,000,000. Since federal income tax law allows net operating losses to be carried back two years, the $2,000,000 loss can be carried back to offset taxable income in years 2006 and 2007, resulting in refunds of the $595,000 paid for those years. Losses not used in the carry-back years are permitted to be carried forward for twenty years. This would leave $250,000 of net operating loss available to be carried forward.

Note that the Alternative Minimum Tax (AMT), which has affected many individual taxpayers, also applies to corporations. This may limit the ability of the corporation to fully recover its previously paid taxes through carry back of a net operating loss. On the bright side, AMT rules permit the carry forward of any AMT taxes paid to be used as a credit in future years. Those "Minimum Tax Credits" can be used to offset "regular" tax (non AMT tax) in future years.

Another consideration to be aware of is the ability to quickly recover some or all of the estimated tax payments made by the corporation during the year. Unlike employees whose income taxes are withheld from each paycheck and remitted to the government, corporations remit taxes through "estimated payments," which are usually done on a quarterly basis throughout the year. Instead of having to wait until the corporate tax return is filed to receive a refund of taxes paid, corporations can apply for what is referred to as a "quick" refund. This is done by filing Form 4466 with the IRS after the close of the year, but before the earlier of the un-extended due date of the corporate return or the date the corporation actually files its return. For a calendar year corporation, the un-extended due date is March 15th following the year end. The IRS is required to act upon a refund application filed this way within 45 days from the date it is filed. Note that penalties can apply if the refund requested turns out to be higher than the actual refund allowed when the return is filed.

Corporations that are now expecting losses in a year that was originally thought to be profitable should also consider triggering gains on appreciated assets that the corporation no longer wants or needs. The current year losses could shelter the gains from tax. For example, assume a corporation owned an appreciated asset, such as land, but management resisted selling the asset to avoid paying a higher corporate tax bill. Management may now want to reconsider that option, given the fact that the gain could be offset with current year losses.

Note that capital losses by C corporations receive special treatment. Capital losses incurred by a C corporation can only be used to offset capital gains, not ordinary income. In addition, capital losses not used in the current year are first carried back three years and used to offset capital gains, if any, in those years. To the extent capital losses are not used in the carry back years, they can only be carried forward five years. If not used in the carry back or carry forward period, the capital losses will expire.

The above considerations discussed "federal" income tax rules. Note that in many cases states do not follow the federal rules. For example, the state of New Jersey does not allow corporations to carry back net operating losses. Those losses can only be carried forward and generally for only seven years. The state of New York does allow for a carry back, but the amount that can be carried back is severely limited to a maximum of only $10,000.

John M. Harrison, CPA, is a tax senior manager at EisnerAmper LLP in Hackensack. Member of the New Jersey Society of Certified Public Accountants.
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