Final rules addressing complexities in computing net operating losses stemming from legislation enacted in 2017 and amendments in March appear closer to release now that the White House’s review of the regulations is underway.
According to its website, the Office of Management and Budget’s Office of Information and Regulatory Affairs received final section 1502 regulations September 22 that explain how NOLs under the Tax Cuts and Jobs Act are computed for affiliated groups of corporations that file consolidated returns.
The final IRS and Treasury rules, following up on July 2 proposed regulations (REG-125716-18), will address the absorption of consolidated NOL (CNOL) carryovers and carrybacks applicable to consolidated groups. That includes guidance on applying the 80 percent limit on the use of post-2017 NOLs to offset taxable income (other than taxable income of nonlife insurance companies) for tax years beginning after December 31, 2020.
Because the NOLs generated by nonlife insurance companies are subject to different rules in tax years beginning in 2021, the proposed regs explain how to apply the section 172 rules under the TCJA to consolidated groups that include nonlife members, members that are other than nonlife insurance companies, or both.
The TCJA amended section 172 to, in most circumstances, eliminate NOL carrybacks, limit NOLs to 80 percent of taxable income, and allow carryforwards indefinitely. Pre-TCJA taxpayers could generally carry back losses for two years and forward for only 20 years.
Under the TCJA, life insurance companies are treated the same as other companies under section 172 rather than falling under a special rule. But property and casualty insurance companies can continue to use NOLs to offset 100 percent of taxable income, with their unused losses being subject to the pre-TCJA carryback and carryforward rules.
The Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) modified section 172 to address liquidity issues arising from the COVID-19 pandemic by temporarily repealing the 80 percent NOL limitation and allowing deductions for loss carryovers and carrybacks to fully offset taxable income for tax years beginning before January 1, 2021.
The law also allows companies to carry back losses arising in tax years from 2018 through 2020 for up to five years before the year of the loss.
Under Treasury’s proposed changes to reg. section 1.1502-21, a consolidated group’s NOL deduction would be limited to the sum of the pre-2018 NOLs and the post-2017 NOLs after applying the 80 percent limitation carried to tax years beginning after December 31, 2020.
For groups with nonlife insurance companies and other members, the proposed regs clarify that the application of the 80 percent limitation within a consolidated group depends on the status of the entity whose income is being offset in a consolidated return year rather than the status of the entity whose loss is being absorbed.
To effectuate that rule, the proposed regs introduce a two-factor computation: a “residual income pool” for group members that aren’t nonlife insurance companies, and a “nonlife income pool” for those members’ income.
Recommended Clarifications
In an August 7 comment letter, Scribner Hall & Thompson LLP said it agreed with the two-factor, two-pool approach “to determine the amount of the 80-percent limitation on taxable income that can be offset by CNOLs.”
The firm also supports the use of the pro rata approach under reg. section 1.1502-21 to determine the amount of property and casualty insurance company losses that can be carried over to other years.
For groups with those types of companies, the regs should clarify that consolidated capital gain net income is allocated between the two pools using a pro rata method similar to the method proposed for using and absorbing CNOLs, the letter said.
Other Scribner Hall recommendations included clarification that the amounts of the residual income pool and the nonlife income pool “refer only to the items of income, gain, deduction, or loss of members of the nonlife subgroup.” The clarification, however, should not prevent nonlife CNOLs from offsetting life subgroup income as permitted by the tax code and reg. section 1.1502-47, which appears to be the intent in the proposed regs, the letter said.
Clarification regarding how much taxable income in each pool is absorbed by a CNOL carryover when each pool has positive taxable income is also needed, according to the firm.
Split-Waiver Election
The proposed regs include by reference the so-called split-waiver election rules — issued at the same time as temporary regulations (T.D. 9900) — that address specific effects of retroactive statutory changes extending the section 172 NOL carryback period, such as those in the CARES Act allowing taxpayers to carry back NOLs arising in tax years 2018 through 2020.
The five-year carryback period in the CARES Act wreaked havoc on some post-2017 merger and acquisition transactions because dealmakers generally didn’t contemplate potential refunds from NOL carrybacks, causing unintended consequences and shifting the economics of some deals after they had closed.
Because the TCJA eliminated the two-year carryback provision for most corporations, purchase agreements generally didn’t have provisions governing whether the acquiring group’s post-acquisition CNOLs attributable to the acquired member could be carried back to the selling group’s prior consolidated return years while the target company was a member of that group.
The temporary regs provided that if a statutory amendment extending the loss carryback period occurs after a consolidated group acquires a new member from another group, the acquiring group may make one of two elections concerning the carrybacks of CNOLs attributable to the new member in a year in which the amended carryback rules apply.
The options are to waive the part of the extended carryback period during which the acquired member was a member of a former consolidated group (amended statute split-waiver election), or to waive only the additional carryback years provided under the amended statute (extended split-waiver election).
The acquiring group may make a separate irrevocable election for each tax year to which the amended carryback rules apply.
Practitioners welcomed the split-waiver election regs for CNOL carrybacks following the CARES Act, but contended that myriad situations without further guidance could cause inequitable results for deals negotiated after the TCJA was enacted under the presumption that companies couldn’t carry back losses.