New proposed and temporary regulations issued by the IRS explain the computation of net operating losses (NOLs) and give more flexibility to consolidated groups in determining the treatment of NOLs. The new temporary regulations make it possible for consolidated groups that acquire new members to elect to waive all or part of the pre-acquisition portion of the extended carryback period for NOLs of acquired members.
To understand the changes, it is useful to review the recent NOL amendments that made the latest rules necessary.
The treatment of NOLs has changed since 2017 when the Tax Cuts and Jobs Act (TCJA) was enacted. Previously, NOLs could be carried back two years and forward 20 years. Under TCJA, NOLs arising after 2017 could no longer be carried back but could be carried forward indefinitely. The more recent CAREs Act changed the carryback rules again by requiring a 5-year NOL carryback period for losses incurred after December 31, 2017, and before January 1, 2021, unless the taxpayer waives the extended carryback period.
For consolidated groups, the retroactive extension of the carryback period caused timing problems with waivers for NOLs of acquired members that previously were part of another consolidated group. Under the prior rules, consolidated groups had to elect to make waiver elections on the return for the year of acquisition. For reinstated carrybacks, the election period already would have passed. So, the new rules allow the election to be made in a tax year after the year of acquisition so consolidated groups can file waivers for the extended carryback period.
These elections are called split-waiver elections, and the new options are explained below.
Under the general rules, consolidated groups may make an irrevocable election to give up the entire carryback period of a consolidated net operating loss (CNOL) for any return year, called a “general waiver election.” This election may not be made separately for a particular member. However, a ‘‘split-waiver election’’ is allowed for acquired members that were previously members of another group.
As noted above, because consolidated groups would not have filed split-waiver elections in acquisition years before the carryback was extended, the new temporary regulations allow split-waiver elections in two additional circumstances:
1) the consolidated group acquired one or more members and have CNOLs that, under amended carryback rules, are eligible to be carried back for more years than under law in effect at the time of the acquisition; and
2) a consolidated group may elect to waive the carryback CNOLs of an acquired member to the extent those losses would have been carried back under prior law, meaning the two-year default carryback period.
Taxpayers may apply the temporary regulations to any CNOLs arising in a taxable year beginning after December 31, 2017.
Proposed Regulations on Computing NOLs
The proposed regulations provide guidance for consolidated groups regarding the application of the 80% limitation that applies after 2020. Under the TCJA and CAREs act, the NOL deduction is the sum of:
- The total of the NOLs arising before January 1, 2018 (pre-2018 NOLs) that are carried to that year; plus
- The lesser of:
- The total of the NOLs arising after December 31, 2017; or
- 80% of taxable income less pre-2018 NOLs (the 80% limitation).
Note that the CAREs Act also allows a 5-year carryback of NOLs arising in a taxable year beginning after December 31, 2017, and before January 1, 2021. Taxpayers can elect out of the 5-year carryback.
IRS Example: Pre-2018 and post-2017 CNOLs.
Acme is the common parent of a consolidated group. No member of the Acme group is a nonlife insurance company or is engaged in a farming business, and no member of the Acme group has a loss that is subject to the separate return limitation year rules. The Acme group had the following consolidated taxable income or CNOL for the following taxable years:
- All $30 of the Acme group’s 2018 consolidated taxable income is offset by the 2017 CNOL carryover without limitation. The remaining $60 of the Acme group’s 2017 CNOL is carried over to 2021.
- The Acme group’s $40 2019 CNOL is carried back to the five taxable years preceding the year of the loss, 2014, and offsets $40 of the Acme group’s 2014 consolidated taxable income.
- The Acme group’s CNOL deduction for 2021 equals the amount of pre-2018 NOLs carried to 2021 ($60) plus the group’s post-2017 CNOL deduction limit, $48, computed as the lesser of:
- The total of the NOLs arising after December 31, 2017 ($100) or
- 80% of the current year taxable income ($120) less pre-2018 NOLs ($60)or $48.
Thus, the Acme group’s CNOL deduction for 2021 equals $108 ($60 pre-2018 NOLs carried to 2021 + $48 post-2017 CNOL deduction limit). The Acme group offsets $108 of its $120 of 2021 consolidated taxable income, resulting in $12 of consolidated taxable income in 2021. The remaining $52 of the Acme group’s 2020 CNOL ($100−$48) is carried over to future taxable years.
Nonlife insurance companies are permitted to carry back NOLs two years and forward 20 years, and the 80% limitation does not apply. Farming losses are permitted to be carried back two years and carried forward indefinitely, subject to the 80% limitation. The CARES Act effectively delays the application of the TCJA amendments until January 1, 2021.
The proposed regulations provide guidance on how the 80% limitation on post-2017 NOLs applies to consolidated groups. They also remove obsolete provisions from the rules for consolidated groups that contain both life insurance companies and nonlife insurance companies.
The rules for the NOLs of consolidated groups have changed several times in the last few years, and the recent regulations provide more planning opportunities. The decision on whether to make elections for retroactive years is a complex one involving the review of several tax years. Consult your Frazier & Deeter tax advisor to help you with this analysis.