Net Operating Loss Deduction
BY CHARLES N. WHITEHEAD PARTNER, SAN FRANCISCO OFFICE
Presented at the Tulane Tax Institute, Pensacola, Florida — November, 1955
It has been said many times that determination of income tax is based upon an annual accounting period. This concept is fundamental to the administration of our income tax law, but it contains inherent inequities
resulting from fluctuating incomes. The position of a taxpayer with a steady average income is far preferable to that of a taxpayer with alternating profits and losses. Under a strict annual tax year the taxpayer
with fluctuating incomes pays greatly in excess of a taxpayer receiving
consistent income even though the aggregate net income over a given period may be the same.
LEGISLATIVE HISTORY AND PHILOSOPHY
Early in the game, as early as 1918, (1) it was recognized that some relief had to be provided for taxpayers receiving fluctuating income
and the concept of net operating loss was introduced into the Act. With varying characteristics net operating losses remained in the Act until 1933 when a period of depression forced its abandonment. They were reinstated in 1939, (2) and in 1942 the concept of a carry-back in addition to a carry-forward was introduced into the Code. (3)
The rules and periods of carry-overs have changed, but the intent has been to provide a method of averaging income over varying periods. In actual operation the net operating loss carry-over and carry-back does not achieve a complete average because of progressive rates and exemptions, but many business lives have been saved by the application of these provisions which made it possible to recover taxes which under the concept of annual accounting would have been lost to the taxpayer forever.
CHANGES MADE BY THE 1954 CODE The 1954 Code (4) made a number of extremely important changes
1 Sec. 204(b), Revenue Act of 1918. 21939 IRC Sec. 122. 31939 IRC Sec. 122(b)(1).
4All section references, unless specifically indicated otherwise, are to the Internal Revenue
Code of 1954.