Menu
Tax Notes logo

Final Consolidated NOL Rules Leave Substantive Issues Behind

Posted on Oct. 14, 2020

Final rules for determining net operating loss deductions under the Tax Cuts and Jobs Act and coronavirus relief legislation advanced quickly through the regulatory process, but their limited scope precluded tackling some issues.

Treasury and the IRS issued final regs (T.D. 9927) October 13 that include section 1502 rules for the absorption of consolidated NOL (CNOL) carryovers and carrybacks applicable to affiliated groups that file consolidated returns. The regulations address legislative changes made to section 172 by the TCJA and the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136), but exclude the split-waiver election rules issued as temporary regs (T.D. 9900) in July — which also served as text for the proposed regulations.

The rules included in the final regs generally adopt the corresponding proposed regulations (REG-125716-18) published in July, with some clarifications, but it’s notable that “the IRS and Treasury have moved with lightning speed to finalize these regulations” so taxpayers can rely on them, Bryan P. Collins of Andersen Tax LLC told Tax Notes.

Following the August 31 close of the comment period, Treasury on September 22 delivered the regs to the Office of Management and Budget’s Office of Information and Regulatory Affairs for its review, which was completed October 9.

Because the final consolidated return regulations are intended to address legislative changes made by the TCJA and the CARES Act, Treasury and the IRS declined to adopt comments that address issues that they said fall beyond that scope.

“The government’s commitment to the scope of the proposed regs was evidenced by a novel statement in the preamble to the final regs, essentially rejecting a comment requesting guidance for how to compute the nonlife insurance and the residual income pools in the case of consolidated group net capital gain,” Andrew J. Dubroff of EY said.

In that case Treasury and the IRS didn’t adopt guidance to address “an existing issue despite a new application of the issue being created” by the legislative changes, Dubroff added.

Reasonable Approaches

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, most taxpayers could generally carry back losses for two years and forward for only 20 years.

The CARES Act 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 beginning in 2018 through 2020 for up to five years before the year of the loss.

The approaches for implementing the legislative changes in the final regs represent “a reasonable balance between accuracy and administrability, generally by adopting final rules that readily incorporate into the existing CNOL systems,” Dubroff said.

The final rules provide 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. Amendments to reg. section 1.1502-21 address special rules for groups that contain at least one nonlife insurance company and rules for “special status losses,” such those generated by farming activities.

The reg package includes rules for applying the 80 percent limitation to losses arising in a separate return limitation year (SRLY) — one in which a member of a consolidated group files a separate tax return or is included in a consolidated return with another affiliated group — and amends the section 1503 dual consolidated loss regs that reference those rules.

Dealing With Differences

Because the NOLs generated by nonlife insurance companies are subject to different rules in tax years beginning in 2021, reg. section 1.1502-21 explains how to apply the section 172 rules to consolidated groups that include nonlife insurance companies and other members.

The final regs adopt the approach in the proposed regs, which the government says was “uniformly approved” by commentators, who supported the rules for “computing a group’s post-2017 CNOL deduction limit as well as the proposed regulations’ retention of the historical pro rata approach under [reg. section]1.1502-21(b)(2)(iv)(B) to determine the amount of nonlife insurance company losses that can be carried to other taxable years.”

The 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. 

In an August 7 comment letter, Scribner, Hall & Thompson LLP said it agreed with that approach, but it recommended several clarifications, including that consolidated capital gain net income under reg. section 1.1502-11(a)(3) is allocated to the residual income pool and the nonlife income pool using a similar pro rata method in the proposed regs for the use and absorption of CNOLs.

Treasury and the IRS noted that reg. section 1.1502-11 doesn’t provide explicit rules for allocating consolidated capital gain net income among members for “determining the amount of each member’s income that is offset by losses (whether incurred in the current year or carried over or back as a part of a CNOL or consolidated net capital loss).”

The government acknowledged that absent express rules, practitioners generally apply the principles under reg. section 1.1502-21(b)(2)(iv), but it declined to incorporate the recommendation for specific rules for allocating consolidated capital gain net income to the two pools. That “would exceed the scope of these final regulations” intended to implement changes of the TCJA and the CARES Act, the regs’ preamble says.

The final regs include rules for consolidated groups with losses from farming activities, which may be carried back two years for tax years beginning after December 31, 2020. The regs closely follow the 2012 proposed rules (REG-140668-07) for analogous situations.

Treasury and the IRS clarify in the new regs that the maximum amount of the farming loss is the group CNOL rather than the NOL of the member that generated the farming loss. The regs also provide an apportionment rule that allocates the farming losses to various members to determine the amount of the CNOL that can be carried back.

‘Substantive Revisions’ Needed

The final regs include updates to reg. section 1.1502-47 for determining, allocating, and using losses among members of a life-nonlife consolidated group. Those changes generally reflect removing or revising provisions no longer applicable because of changes made by the CARES Act, the TCJA, and prior tax legislation.

In an August 24 comment letter, the American Council of Life Insurers urged the government to resolve other life-nonlife issues and provide “substantive revisions necessitated by fundamental statutory changes in the taxation of insurance companies and by the development of the generally applicable consolidated return regulations.”

The group emphasized that it’s “imperative that the use of [a life-nonlife group’s] losses follow the principles of the broader consolidated return regulations to the extent possible and that unnecessary restrictions not be perpetuated that, subsequent to significant law changes, no longer serve an appropriate policy purpose.”

Treasury and the IRS said they received several comments concerning necessary changes to reg. section 1.1502-47, but “such changes are beyond the scope of these final regulations.” The government said it welcomes further recommendations “for purposes of potential future guidance.”

Loss Limitation Rules

A consolidated group member generally offsets its NOLs against the group’s taxable income unless the member’s NOL is incurred in a tax year other than the group’s current tax year. If that exception applies, the SRLY limitation rule — designed to reduce loss trafficking — would limit the group’s absorption of the SRLY member’s NOLs to the net income generated by that member as a member of the group.

Under the general SRLY limitation rule, the SRLY member’s net positive or negative contribution to income is tracked using the so-called cumulative register approach, in which the full amount of current-year income increases the member’s register and the full amount of the current-year absorbed loss decreases the amount.

The final regulations modify the SRLY rules to address the group’s absorption of a SRLY member’s losses that are subject to the TCJA’s 80 percent NOL limitation rule by requiring a reduction in the cumulative register of the full amount of income that would be necessary to support the SRLY member’s deduction. Thus, the SRLY member’s cumulative register, for example, would be reduced by $100 rather than the $80 of losses that would be absorbed by the group.

That change is necessary to ensure that “the SRLY member achieves the same Federal income tax result as if the SRLY member continued to be a stand-alone entity,” according to the proposed regs’ preamble.

Several multinational companies urged Treasury and the IRS in an August 31 letter to clarify that the SRLY 80 percent NOL limitation rule doesn’t apply for purposes of computing the dual consolidated loss (DCL) rules under section 1503(d), which incorporate the mechanics of the SRLY rules.

Otherwise, applying the proposed rule would undermine the policies underlying the DCL rules, which generally prevents a domestic corporation subject to income tax of a foreign country or a foreign branch separate unit from using DCLs to offset income of another group member.

Treasury and the IRS agreed and modified reg. section 1.1503(d)-4(c)(3) to reflect that the application of the SRLY 80 percent NOL limitation rule under reg. section 1.1502-21(c)(1)(i)(E) doesn’t apply for purposes of the DCL rules.

Split-Waiver Elections

Under the consolidated return regs, when a consolidated group acquires a member from another consolidated group, the acquiring group may make an irrevocable election under reg. section 1.1502-21(b)(3)(ii)(B) to waive all CNOLs attributable to the target corporation for the portion of the carryback period during which it was a member of another consolidated group before joining the new group.

One commentator recommended that the rules be “expanded to allow a split-waiver election if the acquired corporation was not a member of a consolidated group in the carryback year,” the regs’ preamble said.

The July temporary regs modify the split-waiver election rules for consolidated groups that acquire members from other consolidated groups after a retroactive statutory extension of the section 172 NOL carryback period, such as the provision in the CARES Act.

Because the scope of the final CNOL regs doesn’t include the split-waiver election provisions, Treasury and the IRS declined to adopt a recommendation to broaden the rules, but said they will continue to consider it in finalizing the temporary regs.

Thus, the temporary regs remain in effect, “and it remains to be seen whether the government will adopt changes in response to the comments on those rules,” Dubroff said.

Copy RID