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Company Says ‘Vintage’ NOL Rule Vital in Economic Downturn

Posted on Mar. 20, 2020

The loss limitation regulations’ proposed transition rule should apply equitably to all net operating losses that arise before the final regulations are effective, which is even more important in an economic slowdown, a corporation says.

YRC Worldwide Inc. (YRCW) commended Treasury and the IRS for “broadening the transition relief” in their January proposal (REG-125710-18), modifying the 2019 proposed section 382(h) regs. But the rules don’t go far enough to mitigate the “unnecessary and punitive effect” for companies with a post-effective-date ownership change, the freight transportation service provider said in a March 16 comment letter.

“Creating an equitable and fair transition period for the use of pre-effective date NOLs is incredibly important at this time,” according to YRCW.

“A transition rule that distinguishes between pre-effective date tax attributes and post-effective attributes is an equitable and practical solution,” the letter says. Thus, the final regulations should adopt a “vintage” approach and only apply to NOLs incurred after the effective date, according to the company.

Treasury and the IRS have delayed the applicability date of the final section 382(h) loss limitation regulations until 30 days after the final regs are published in the Federal Register. The government also provided a transition relief provision that would exempt specified ownership changes that occur after that date and allow affected taxpayers to rely on prior guidance that would otherwise become obsolete.

“Even before the economic slowdown that Americans are currently experiencing and that is likely to worsen,” the proposed regs would substantially limit a company’s “ability to offset against built-in income all [NOLs], including those arising before final regulations are issued, if an ownership change occurs after such regulations are final,” YRCW said.

The company pointed to the much-criticized treatment of income from wasting assets in determining what constitutes recognized built-in gain under proposed regulations that would otherwise significantly limit a corporation’s ability to use losses following an ownership change.

Practitioners are challenging the government’s decision to eliminate the taxpayer-favorable section 338 safe harbor in Notice 2003-65, 2003-2 C.B. 747, which would treat forgone amortization as recognized built-in gain, and instead mandate a modified approach to the section 1374 safe harbor.

“While our economics have benefited significantly from the post-financial crisis economic recovery, we now face further economic uncertainty due to the impact on the economy of COVID-19,” YRCW said.

The proposed regulations “would result in the immediate diminution of the value of any pre-effective date NOLs, which could only be ameliorated through, for example, asset sales that would be nonsensical, particularly in this economic environment,” according to the company.

“A transition rule that permits Notice 2003-65 to continue to apply to pre-effective date NOLs and other tax attributes . . . will avoid the draconian effects of destroying the ability to use such attributes under the cut-off approach” that's based on whether the ownership change occurs before or after the final regs’ effective date, YRCW said.

With the coronavirus and resulting economic effects, there are going to be more companies with NOLs, which elevates the importance of the effects of the section 382(h) rules, Todd Reinstein of Pepper Hamilton LLP told Tax Notes.

The proposal is “reasonable and based on an existing concept already in the [section] 382 regulations,” Reinstein said, noting that YRCW cites the successive ownership change rules under reg. section 1.382-5(d) as an example of where taxpayers must apply different limitations under section 382 simultaneously.

More Detrimental Effects

Section 382 limits a loss corporation’s ability to use NOLs that arose before an ownership change and some built-in losses that existed at the time of the ownership change.

Reinstein pointed out that loss corporations include not only companies with NOL carryovers, but also those with a net unrealized built-in loss — that is, the fair market value of the assets is less than the aggregated adjusted basis of the assets.

If there’s an economic recession like the 2008 downturn, then banks, for example, could have a net unrealized built-in loss, Reinstein said.

That’s important because the proposed regs not only eliminate the wasting asset approach but also would modify the section 1374 approach, which results in a “more stringent” net unrealized built-in loss calculation that will negatively affect the company’s ability to use losses in the downturn, according to Reinstein.

Section 382(h) limits built-in pre-ownership-change losses that can offset future taxable income for a five-year period following the ownership change.

For loss corporations with a net unrealized built-in gain, the section 382 limit is increased by the amount of its recognized built-in gain. For corporations with a net unrealized built-in loss, recognized built-in losses are subject to the section 382 limitation as if they had been incurred before the ownership change.

Potential Focus

People are concerned that the disruption in business caused by the coronavirus crisis may create more tax losses this year than anticipated, according to Reinstein.

There’s going to be increased pressure to use those losses and create economic recovery, but the proposed section 382(h) regulations “as they currently stand don’t help that,” Reinstein said.

Reinstein noted that in 2008 Treasury modified section 382(h) rules for calculating the limitation in some situations, which was helpful.

In Notice 2008-83, 2008-42 I.R.B. 905, the IRS liberalized the use of an acquired bank’s built-in asset losses.

With an economic downturn and considering the relief the government is contemplating, the loss utilization and ownership change rules could become a focus, Reinstein said.

Senate Republicans proposed late March 19 several tax code changes to provide more flexibility for both individuals and businesses. One provision, modifying the section 172 NOL rules, would temporarily remove the taxable income limitation to allow a company to fully offset income with NOLs. The proposed legislation would also allow businesses to carry back losses for five years.  

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