“Carryforward” policy in Arizona leaves state at competitive disadvantage

PHOENIX – The Arizona Chamber Foundation today released a Policy Brief that examines Arizona’s taxation of business profits over a multi-year period and assesses how the state’s treatment of net operating losses (NOL) compares to other states.

The Foundation paper, “Net Operating Loss in Arizona: Taxing Business Profits on a Multi-Year Basis,” looks at how the federal government and states with a corporate income tax allow NOL to be deducted against past and future profits to more accurately measure a business’ financial performance over time.

A business has an NOL when its tax-deductible expenses exceed taxable revenues during a fiscal year. The annual accounting method creates an unbalanced tax burden by preventing businesses from utilizing the excess deductions generated in an NOL year. Recognizing the need for a multi-year perspective, the federal government and most states mitigate this unbalance by allowing businesses to “carry back” and “carry forward” an NOL.

A majority of states have elected to follow the federal standard of allowing a 20-year carryforward. These states recognize that allowing losses to be deducted against future profits measures profitability over a time period that more closely corresponds to a business’s investment horizon. Many small businesses, new ventures, high-tech businesses and manufacturers lose money for a number of years before crossing into profitability.

Without a NOL carryback or carryforward, a business that experienced losses of $1,000 per year for five years followed by profits of $1,000 for five years would pay taxes on the latter period. Meanwhile, a business that broke even for 10 years would have no income liability despite earning identical profits over the same period. It would be inequitable for the first business alone to have a positive income tax liability merely because of the timing of its losses and profits.

“Arizona is one of only five states with a corporate income tax that has an NOL carryforward of only five years,” Arizona Chamber Foundation executive director Suzanne Taylor said. “Start-up businesses and other industries requiring additional time for employment growth are disadvantaged by the current limitations in Arizona’s business tax policy. Lengthening the opportunity for NOL deduction could aid in the promotion of investment within Arizona and the attraction of business from outside the state.”

The Foundation’s analysis of other states’ carryforward policy finds that 26 states have a carryforward that conforms to the federal government’s 20-year policy, including regional competitor Colorado.

The complete policy brief can be read here.