The Coronavirus Aid, Relief, and Economic Security Act (CARES Act, H.R. 748) included changes to the federal income tax loss (NOL) carryforward provisions under Section 172 of the Internal Revenue Code. One of the significant provisions allows a corporate taxpayer to carry back NOLs arising in tax years ending after December 31, 2017 and beginning before January 1, 2021 (i.e., 2018, 2019, and 2020), for five years.[1]
Split Waivers
Absent a waiver, a corporation with an NOL for taxable years ending after December 31, 2017 and beginning before January 1, 2021 must carryback the NOL to the first year of taxable income beginning with the fifth preceding tax year. For example, a calendar year corporation with an NOL in 2018 must carryback the NOL to taxable year 2013 and offset income in reported in the 2013 return first, with the residual NOL carried forward to the succeeding tax years until fully absorbed. This rule applies to a corporation that was included in the filing of a consolidated group in which it is not a member at the time the NOL was incurred. If the corporation was a member of another consolidated group before leaving the group (e.g. the member was sold or spun off), then the NOL carryback would be reported by the member’s former consolidated group, and that group (rather than the member’s current consolidated group) would receive the cash refund.
Companies that were part of consolidated groups either wishing to avoid this situation or that are contractually bound not to carryback their losses to former consolidated groups can file an election with its tax return in the year the loss was incurred to completely waive any ability to carryback the NOL to prior years. A “split-waiver” election may also be available when a former corporate member of one consolidated group departs and becomes a member of another consolidated group.[2] If a split-waiver election is made, the acquiring consolidated group irrevocably relinquishes, for all consolidated NOLs attributable to the new member, the portion of the carryback period for which the new member was a member of a prior consolidated group. The benefit of the split waiver is that it allows a consolidated group to carryback an NOL and offset income with the subject NOLs accumulated in the years the new member was included in the new consolidated group. Absent the split waiver, the cash refund would be paid to the old consolidated group. A split-waiver election must be made in the year in which the new member becomes a member of the consolidated group by including it with the acquiring group’s return for the tax year in which the acquired member joined the acquiring group.
Example
The following illustrative example describes the mechanics and implications of the split waiver. In September 2018, P acquired all of the outstanding stock of T from X, the common parent of the X consolidated group. T recorded significant taxable income from 2016 to 2018, when it was included in the X consolidated return. The purchase agreement between P and X is silent as to the ability of P to make a split waiver election (because before the CARES Act, no carrybacks were permitted). Because there was no effective carryback provision in 2018, P did not file a split waiver election with its 2018 consolidated return filing. The P group reported federal taxable income in 2019, including $10,000 attributable to T. P then incurred a tax loss in 2020, including $1,000 that is attributable to T. If P does not waive the right to carryback the consolidated NOL in 2020, it will be required to carryback T’s $1,000 loss to the 2016 tax year, when it was a member of the X consolidated group. As a result, any tax refund associated with the $1,000 loss will be paid to X, and X will be entitled to keep any cash refund. Absent the ability to file a late split waiver, P’s only option was to file an all-or-nothing election to waive the NOL carryback for the entire group, which comes at the price of forgoing other portions of the 2020 loss that could otherwise be carried back to its own prior year tax returns.
Special Impact of Carryback Rules on Certain Consolidated Groups
Because the TCJA had repealed the carryback provision, many consolidated groups did not make any NOL-related elections for subsidiaries acquired after 2017. The IRS issued Rev. Proc. 2020-24 in response to this situation, and provided guidance to allow taxpayers to waive the carryback period in the case of NOLs arising in a taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2021. Revenue Procedure 2020-24, did not, however, provide relief for split-waiver elections or otherwise provide guidance specifically directed toward consolidated return groups.
On July 2, 2020, the Treasury Department and the IRS issued proposed and temporary regulations to address issues for certain taxpayers with consolidated NOLs.[3] The temporary regulations provide rules with respect to a consolidated group’s ability to make a split-waiver election by permitting either an amended statute split-waiver election or an extended split-waiver election for a portion of an NOL that is attributable to an acquired member that arises in a tax year to which the amended carryback rule applies.[4] The election is on a tax-year-by-tax-year basis for all or a portion of the carryback period for NOLs attributable to an acquired member for pre-acquisition years during which the acquired member was a member of a former consolidated group.
The temporary regulations generally apply to any consolidated NOL arising in a tax year ending after July 2, 2020. However, a special provision allows taxpayers to apply these temporary regulations to any consolidated NOLs arising in a tax year beginning after December 31, 2017. The temporary regulations’ applicability will expire on July 3, 2023.
Refundable AMT Credits
In addition to taking into account the complexities associated with NOL carrybacks and the refund of a corporation’s regular federal tax liability, companies may also need to consider the application of the alternative minimum tax (AMT) if the carryback is applied to tax years before 2018. Corporate taxpayers that were subject to regular tax liability were also subject to AMT for tax years 1986 through 2017. Under those rules, a corporation paying the AMT is allowed a Minimum Tax Credit (MTC) in a subsequent tax year equal to the amount of the AMT paid to the extent its regular tax liability exceeded its AMT in the subsequent years. Unutilized MTCs are carried forward.
Under the pre-2018 rules, a corporate taxpayer carrying back an NOL could offset up to 90 percent of its alternative minimum taxable income with an AMT NOL deduction. As a result, a taxpayer that eliminated its regular tax liability with an NOL carryback would still typically owe AMT for the carryback year because of the AMT limitation This AMT liability would be converted into an MTC and used to offset regular tax paid in subsequent years. When Congress enacted the TCJA and repealed the AMT for tax years after 2017, it created transition rules to refund the MTC carryforwards that existed at the end of 2017.[5] The CARES Act modified these transition rules to allow for a refundable MTC in the first year available.[6]
When Congress enacted the five year carryback, a threshold question arose as to the appropriate amount of the AMT NOL. This issue arose because there was no AMT imposed in post-2018 years, but there was AMT in pre-2018 years. On May 27, 2020, the IRS released a list of FAQs regarding the procedures for claiming a refund of the AMT credits. The FAQs stated that the amount of the AMT NOLs arising in a post-2018 tax year would be $0 for carryback claims filed after June 1, 2020. This departure from the former rule of a 90% AMT NOL deduction meant that many taxpayers would see a significant portion of the NOL carryback creating AMT liability in the carryback years, and create associated large MTC credit carryforwards. The FAQs provided additional clarification regarding the procedure for making the election to claim a refund of 100 percent of a corporate taxpayer’s remaining MTCs that would be carried forward into its first taxable year beginning in 2018.
AMT Rules Applied to Departing Or Departed Members
When a corporate member departs from a consolidated group, the member is apportioned its share of any consolidated NOL carryforwards under Treasury Regulations. The rules for allocating AMT credits to a departing member are less defined. In 1992, the Treasury and IRS released Proposed Treasury Regulation 1.1502-55(h)(6), which included rules for allocating MTC for departing members. The amount of the consolidated MTC allocated to a member is generally the member’s share of the group’s consolidated adjusted net minimum tax for each consolidated return year, reduced by the member’s share of the consolidated adjusted net minimum tax allowable as a consolidated MTC during consolidated return years for which the member was included in the group. A member’s allocable share of the consolidated adjusted net minimum tax is based on its proportionate share of the separate adjusted AMT of the members for the year. The separate adjusted AMT of a member is, in general, the excess of the consolidated AMT for the year over the consolidated AMT for the year computed by excluding the member’s items. This proposed regulation does not have an effective date and the rules suggest that there may be other reasonable methods for computing the allocation of MTCs to a departing member. The preamble to the regulations offer other methodologies that the Treasury considered in creating this rule.
Combining the guidance under the five year carrybacks and the FAQs, an NOL carryback to a former consolidated group into a pre-2018 year may ultimately result in significant MTCs being allocated between the old consolidated group and a departing corporate member. These MTCs are otherwise carried forward to 2018 and become refundable. It is possible that the MTC credit allocation method described in the proposed regulations could alter the recipients claim for refund.
Troutman Pepper Perspective
Corporate taxpayers that were formerly included in a consolidated group that have current NOLs, should consider all of the recent guidance from Treasury and the IRS when determining the methodology and ability to carryback the NOLs. Taxpayers may want to review any agreements between the old consolidated group and the departed member to determine what legal obligations each party has in the respective agreements entered into upon the member’s departure. Taxpayers should carefully review these agreements to determine an acceptable allocation of MTCs between the old group and the departed member. If the agreement is silent, taxpayers may consider applying the allocation methodology in the proposed regulation or explore other reasonable methodologies. In addition, any allocation between the parties will necessarily require negotiation and agreement.
