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Determine the tax liability for the Garvey Corporation

The Garvey Corporation, a C corporation, during its first five years of operation, reported the following taxable incomes (losses):
Year Taxable Income Effective Tax Rate

1 $ 60,000 25 %
2 20,000 20
3 (90,000) -
4 30,000 15
5 (40,000) 18

Required:

a. Explain the net operating loss provisions of the tax code as they would relate to the Garvey Corporation.

b. Determine the tax liability for the Garvey Corporation for years one and two.

c. Determine the income tax refund that Garvey Corporation would realize in year three, assuming the corporation elected to use the carryback provision for its net operating loss.

d. Determine the required income tax payments for year four.

e. Determine the income tax liability (refund) realized in year five.

f. If the Garvey Corporation believes its business is about to "take off"and that future incomes will exceed all previous levels, resulting in higher tax rates, would you advise Garvey Corporation to forgo the carryback provision for its year five net operating loss? Why or why not?

Solution Preview

a. Explain the net operating loss provisions of the tax code as they would relate to the Garvey Corporation.

The general provisions for corporate NOL (net operating loss) carrybacks are:
1. Corporate tax law allows for a recovery of taxes paid in prior years before a loss year. Effectively, the amount of the loss can be offset against prior profitable years, and a refund of tax paid can be refunded.
2. A carryback rather than a carryforward is the required method. Only an election to carryforward will modify the standard provision for a carryback.
3. A tax loss in any given year can be carried back to offset taxable income in a prior year. The earliest year that can be offset has changed several times in the recent past. I believe it is currently only three years but has been five years at times. In this case, there is no issue because it is a new company and the first NOL in year 3 would be carried to year 1 regardless.
4. An NOL is always carried to the earliest year first. If the NOL is not fully utilized in that earlier year, then the remaining amount can be carried forward to the next earliest year. In this case, the loss carries from year 3 to year 1 and then the remainder to year 2.
5. Any unused loss in the carryback period will carry forward. In this case, there is ...

Solution Summary

The 966 word solution provides a comprehensive discussion of the law, and the procedures required to comply with the law for net operating loss carrybacks and carryforwards. Included is a calculation for Garvey.

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