Asymmetric Taxation of Business Gains and Losses

The current tax treatment of operating losses

If a business has tax liability from the prior two tax years, it may carry the net operating loss (NOL) back to offset that liability. However, if the NOL exceeds its profit from the recent two years, the business cannot exhaust the NOL deductions through carryback. It can carry the NOL forward to be used as a NOL deduction against future taxable income. The current U.S. law allows NOL to be carried forward up to 20 years.  

When all NOLs in this tax year are completely carried back to prior years, this firm could immediately utilize all such NOLs and get full NOL deductions. However, if the business must wait for years to deduct its NOLs, the real value of the tax loss is diminished, due to inflation and the time value of money. The deferred tax benefits or refundability of a certain amount of NOL will be worth much less to the business.

Tax asymmetry on business profits and business loss

Current law taxes profits immediately, while losses often reduce taxes only with a delay. A perfectly symmetrical treatment of losses and profits would require the income tax value of a loss to be refunded in the year the loss is incurred, just as profits are taxed immediately as they occur. If the losses are carried forward, the real value of losses should be preserved by adjusting them by an appropriate rate of inflation and the normal real return to capital (in effect, augmenting them by an appropriate interest rate).  Instead, U.S. tax systems operate under a partial loss-offset system where firms can only carry the fixed nominal balance of their losses forward up to 20 years without any interest-like adjustment added to lower future taxable income.

The impacts of partial refunding of net operating losses

Tax asymmetry penalizes new firms disproportionately. New businesses usually run losses for several years before generating profits. There is no way for them to carry back the losses or utilize the NOL deduction…

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