[co-author: Brittany Johnson]*
Whether you are in the process of an equity transaction in 2020 or completed one in 2018 or 2019, you may have significant federal income tax planning opportunities. Under prior law, the ability to use net operating losses (NOLs) generated after December 31, 2017 to offset taxable income was limited to 80 percent of a taxpayer's taxable income for tax years beginning after December 31, 2017, and could only be carried forward, not back.1 The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)2 allows for certain carrybacks and removes the 80 percent limitation.3
Reinstatement of the Carryback Period
Under the CARES Act, a taxpayer can carryback NOLs arising in tax years ending after December 31, 2017 and beginning before January 1, 2021 (2018, 2019 and 2020) to each of the five preceding tax years.4 The effective date for this rule applies to tax years beginning after December 31, 2017 and to NOLs arising after December 31, 2017 but carried to tax years beginning on or before December 31, 2017.5 Taxpayers must consider several items when deciding on whether to carryback an NOL.6
M&A Considerations
As part of the new carryback opportunity under the CARES Act, taxpayers may need to determine who controls the refund if the company receiving the refund was acquired after 2017. Before the tax changes made in 2017, the treatment of refunds related to transaction-year NOL carrybacks was sometimes addressed in merger agreements. In these situations, sellers often would argue successfully that they were entitled to tax refunds from the carryback of losses to preclosing tax years. After the tax law changes made in 2017, transaction-year losses likely would just result in NOL carryforwards, and thus the parties may have negotiated potential purchase price increases assuming the use of some amount of those NOLs by the buyer. With the reinstatement of the carryback provisions, buyers and sellers may revert to the type of negotiations in their acquisition agreements that were in place before the 2017 tax changes. For 2018 and 2019 transactions, it may be useful for buyers to review their stock purchase or merger agreements for any discussion of carrybacks with respect to the target company and who is entitled to any refunds for pre-closing tax years.7
Refunding Interest from Leveraged Transactions
Before the 2017 tax changes, a carryback claim was subject to the corporate equity reduction transaction (CERT) rules, which limited the cash refund and reduced the immediate benefit of certain highly leveraged transactions for some NOL carrybacks. A CERT arose when an acquisition of stock or assets was accomplished by the use of borrowed funds. The CERT rules attempted to limit the attractiveness of these transactions by depriving the acquirer of an immediate carryback refund for its borrowing costs. Because the CERT rules have been repealed, the interest component in a carryback claim is no longer subject to reduction, other than for the section 163(j) interest limitation, which may provide an additional carryback benefit for certain taxpayers.
Special Rules for Section 965 Years to Carrybacks
Certain taxpayers may choose not to carryback an NOL to a year in which the section 965 transition tax was applied. For example, if a corporation is a deferred foreign income corporation (DFIC), it is required to include accumulated post-1986 deferred foreign income in its subpart F income with respect to its last taxable year beginning before January 1, 2018 (the inclusion year). A U.S. shareholder of a DFIC may elect to not take into account the inclusion amount for determining the shareholder’s NOL for the tax year or the amount of taxable income for the tax year. The CARES Act provides that, if an NOL arising in tax years 2018, 2019 or 2020 is carried back to a tax year in which there is inclusion of deferred foreign income under section 965(a), the taxpayer will be deemed to have made an election under section 965(n), unless the taxpayer makes an election under section 172(b)(3). If the election is made, instead of relinquishing the entire carryback period, the taxpayer may exclude only the tax years in which section 965(a) income is included from the carryback period.
A taxpayer may choose to do this for a few reasons. First, the taxpayer may have used foreign tax credits to offset the section 965 inclusion. By applying the NOLs instead of the credits, the foreign tax credits would be carried forward and may expire unutilized. Also, because the taxpayer had the option to defer the payment of the section 965 inclusion over an eight-year period, the IRS might deem the carryback NOL as one or all of the payments due on the section 965 inclusion, and thus not pay a cash refund from the NOL carryback.
Endnotes
1 Under the Tax Cuts and Jobs Act (TCJA), for NOLs arising in tax years beginning after December 31, 2017, the deduction was limited to the lesser of (1) the aggregate of NOL carryovers and carrybacks to such a year or (2) 80 percent of taxable income for the tax year to which the loss is carried, without regard to certain deductions. 2017 TCJA, Pub. L. No. 115-97.
2 CARES Act, P.L. 116-136.
3 The CARES Act repeals the 80 percent limitation for tax years beginning before January 1, 2021. The effective date applies to tax years beginning after December 31, 2017 and for NOLs arising after December 31, 2017 but carried to tax years beginning on or before December 31, 2017.
4 CARES Act, P.L. 116-136 § 2303(b)(1).
5 CARES Act, P.L. 116-136, §2303(d)(2).
6 For example, if an NOL is carried back and prior-year GILTI is offset by the NOL carryback, the value of the carryback may be reduced and possibly eliminated if the section 250 deduction is lost because it is calculated based on the GILTI that remains after NOLs have been applied.
7 Taxpayers who were members of a consolidated group need to consider the availability NOLs and the SRLY rules.
* Law Clerk
