Amend the Borrower’s Tax Return and Help Pay Back A Loan – How NOLs Can Generate Cash That Can Be Used to Retire Debt

Recently, a potentially significant change was made to the tax law that could be used by once-successful businesses to generate cash to pay down debt. Under the new law, a business is now able to carry back a net operating loss (NOL) sustained in 2008 or 2009 for five years. This is a major change from the previous law, which limited the NOL carry back period to two years. Workout professionals should be aware of this tool, as it may prove to be a valuable source of cash that can be used to deleverage a business.

The JMBM Special Assets Team™ has used NOL carry back provisions to help pay off troubled loans, but the new law potentially increases the chances of reeling in some serious found money. The additional three years of carry back losses makes it possible for a company to get a refund from the IRS for taxes paid up to five years ago. Why is that critical? Many companies were making a lot of money three, four and five years ago, and they were paying taxes on that money.

This is first of two articles where we will discuss the newly expanded NOL carry back period, show how it can generate significant cash and explain how bankers can help their troubled borrowers apply the unexpected cash windfall to pay down debt.

The practical effect of an NOL loss carry back can be significant. Assume ABC Corp had taxable income of $1 million in 2004, 2005 and 2006, broke even in 2007 and 2008, but had a $3 million loss in 2009. Under existing law, ABC Corp could carry back its losses for two years, but since it had no taxable income in 2007 and 2008 anyway, it received no benefit from the carry back. Instead, ABC Corp would be able to carry forward its 2009 losses for the next 20 years – but that assumes that ABC Corp will actually be able to continue in business and make enough profit to generate tax liabilities in the future.

Under the new law, ABC Corp could conceivably carry back most of the $3 million in losses and apply it to the years 2004, 2005 and 2006, thus offsetting most of the $1 million in income it had in each of those years. Since ABC Corp paid significant taxes in 2004, 2005 and 2006 on that income, it would now be entitled to a refund, thanks to the new extended carry back period. There are a few technical limitations, most notably that only fifty percent of the taxable income in the fifth carry back year can be offset by the NOLs carried back to that year.

Frequently, a company that sustains a significant loss runs short of cash and defaults on its credit facilities, either by violating financial covenants or simply because it is unable to service the debt. Using our example, if ABC Corp has troubled loans, it could use the “found money” from its newly permitted carry back to amend its tax returns for 2004, 2005 and 2006. The cash that is generated from the newly authorized tax refund can be applied to pay down ABC Corp’s loans and make peace with its bankers – if its bankers are sharp enough to cut a deal with ABC Corp before the “found money” is put to other uses!!

As you review the financial statements of your borrowers who have fallen on difficult times, take a moment to look back at their results over the previous five years. In particular, focus on the amount of tax paid by the borrower in the newly eligible carry back years. A quick review should tell whether there is a possibility of generating a refund that could be put to good use – paying down debt.

Our next post will discuss a few techniques we have used to “guide” tax refund cash into an account that retires bank debt.

This is Dick Rogan, bank lawyer and author of www.SpecialAssetsLawyer.com, signing off for now. Join us again soon to check out what’s new in the World of Workouts.

Year after year, day after day, workout professionals in the know rely on JMBM’s Special Assets Team™ to handle problem commercial and real estate loans. Whatever problem loans you have, chances are, we’ve seen it. Give us a call.

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Our Perspective. JMBM represents commercial banks, special servicers, private lenders, asset-based lenders, hard money lenders and factors. We help lender clients throughout the United States craft business and legal solutions to their commercial and real estate troubled loans. For more information, please contact Dick Rogan at RRogan@JMBM.com, or (415) 398-8080.

Richard A. Rogan is Chair of the JMBM Special Assets Team™. He also serves as the co-managing partner of JMBM’s San Francisco office and co-chair of its Bankruptcy Practice Group.

JMBM’s Special Assets Team™ has represented hundreds of lenders in California and throughout the United States. We regularly appear in bankruptcy courts, district courts and superior courts. We are proud to serve as trusted counsel and advisors who look for a business solution and try to help lenders find the best possible resolution for each troubled loan. Whether a loan is being newly documented, restructured or litigated, JMBM’s Special Assets Team™ has the skill, know-how and experience to solve your problem in a practical no-nonsense way.

NOTE TO CONSUMERS: As a matter of Firm policy, JMBM does not represent individual consumers who have disputes with their lenders. Many lenders have specialized consumer workout professionals who have the time to help consumer borrowers. There are many fine attorneys who specialize in representing consumers. Individuals with consumer lending problems should contact a lawyer or law firm who specializes in consumer insolvency and bankruptcy in their local area. When in doubt, we suggest you contact your local bar association’s Lawyer Referral Service. [For example, see Bar Association of SF or LA County Bar Association Lawyer Referral Services]

JMBM does not provide legal advice to consumers, and cannot respond to consumer inquiries.