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Net Operating Loss Utilization Under Scrutiny and Risk of Audit

A business may generally deduct legitimate losses from its taxable income to reduce its tax due to the state and federal government. However, sometimes these losses are greater than income, and thus is called Net Operating Loss (“NOL”). Though obviously not a great sign for company longevity, NOL can still be utilized as a valuable asset for mergers and acquisitions because, if done correctly, a profitable company may merge with a non-profitable company with a NOL, and use the losses of the newly acquired company to offset its own profits, thus reduce its tax. Typically, NOL’s cannot be carried back, meaning that that a business suffering loss in one year cannot deduct them from previous years’ profits, only future years. However, the CARES Act of 2020 permitted net operating losses from some businesses from 2018, 2019, and 2020 to each be carried back for five (5) years each. Due to this allowance, the IRS refunded a total of $17.4 billion to 12,119 corporate taxpayers claiming this benefit through from March 27, 2020, to March 31, 2021. 

While internally reviewing submissions by the SE Division and the LB&I Division, the Inspector General found that 62.5% of the SB/SE Division allowances were incorrect as well as 33% of the LB&I’s Division, thus requiring refund in taxable reductions. The Inspector General has advised that the reasoning behind these errors is because the IRS has not change its examination plans and methodology to address the expanded carryback provision afforded by the the CARES Act, thus they were using outstated methods to process the forms. Despite its redactions, the Inspector General’s report still reveals a vital weakness for the IRS that can be resolved by comparing line 14 of form 1139 and assuring it reflects line 29a of Form 1120. A simple computer program would be capable of checking all Forms 1120 and 1139. A sinply computer program should be able to suffice, but perhaps not due to the 60-year-old state of its computer infrastructure. However, the IRS is set to received a $25,326,400,000 allocation for operations support, including information technology development, thus all companies who have utilized NOL in a merger and acquisition should prepare themselves for a potential audit.