The US Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) on March 27, 2020. In response to the anticipated losses that businesses will suffer by virtue of COVID-19 and the need for liquidity, the Cares Act broadens the ability of business to utilize net operating losses (“NOLs”) arising in tax years beginning after December 31, 2017 and before January 1, 2021. This FGMK Tax Alert highlights the key modifications of the utilization of such NOLs and the potential impact on mergers and acquisitions (“M&A”) transactions that have occurred subsequent to the Tax Cuts and Jobs Act of 2017 (the “TCJA”).
Modification of NOLs by the TCJA
Prior to the TCJA, taxpayers could carry back an NOL for two tax years and could carry forward an NOL for 20 tax years. Taxpayers had to carry the NOL to the earliest applicable tax year. Pursuant to Section 173(b)(3), taxpayers could waive the carryback period for an NOL. A taxpayer could offset 100 percent of taxable income with an NOL.
The TCJA eliminated the carryback of any NOL generated in tax years beginning after December 31, 2017. However, it provided an indefinite period of carryforward of such NOLs. The TCJA also added a new limitation on the utilization of an NOL by limiting the use of any NOL generated in tax years beginning after December 31, 2017 to 80 percent of taxable income (without consideration of NOLs, Section 199A deduction, and the Section 250 deduction). Nonetheless, NOLs generated in tax years beginning prior to January 1, 2018 could continue to offset 100 percent of taxable income if applied in a carryforward tax year.
CARES Act Modifications
The CARES Act modifies the changes made by the TCJA. Following the passage of the CARES Act, NOLs generated in tax years beginning after December 31, 2017 and before January 1, 2021 (i.e., those generally incurred in 2018, 2019, and 2020 tax years) may be carried back to offset taxable income earned during the five-tax-year period prior to the year in which the NOL was incurred. Additionally, there is a temporary removal of the 80 percent taxable income limitation for such NOLs (NOLs generated during this period will be subject to the 80 percent limitation if carried forward to tax years beginning after December 31, 2020). In essence, this allows businesses to fully utilize NOLs to offset 100 percent of taxable income in tax years 2018, 2019, and 2020.
The following chart summarizes these changes to the law.
2 taxable years
NOLs incurred in 2018-2020 taxable years may be carried back 5 taxable years
20 taxable years
|Taxable Income Limitation||
NOL deduction up to 100% of taxable income
NOL deduction limited to 80% of taxable income
NOLs generated in 2018-2020 taxable years provide deduction up to 100 percent of taxable income for 2018-2020 and carryback years. After 2020 tax year, such NOLs are limited to 80 percent of taxable income
Impact on Mergers and Acquisitions
In the typical sale of a corporation in a stock purchase or merger transaction, transaction-related expenses that are deductible for federal income tax purposes, including transaction-related bonuses, option cash-out payments, and portions of a corporation’s investment banker fees and legal fees would result in an NOL. The CARES Act will now allow for the NOL in the year of the sale (assuming the sale took place in 2018, 2019 or 2020) to be carried back up to five tax years.
It is important to note that this benefit is limited to C corporations. Transactions involving the purchase and sale of partnerships and limited liability companies taxed as partnerships, S corporations, or, in most cases, subsidiaries of a larger consolidated group, as well as transactions structured for federal income tax purposes as asset purchases, typically will not be affected by the modification of the NOL rules in the CARES Act.
Parties to an M&A transaction may want to revisit contractual agreements. Due to the TCJA, such documents may be silent as to the waiver of NOL carrybacks (commonly included in agreements pre-TCJA where an acquirer would waive the two-year carryback so as not to impact a selling consolidated group) and tax receivable agreements. If an acquirer does not have expected near-term utilization of an NOL generated due to a transaction, it may warrant a discussion with the seller who may be able to carry back an NOL, which could allow the parties to reach an equitable agreement as to the use and monetization of such NOL.
International Tax Considerations
The CARES Act did not directly modify Section 172(b)(3) which allows taxpayers to waive the carryback of an NOL. However, it did add new Section 172(b)(1)(D)(v) which allows taxpayers to exclude Section 965 inclusion tax years (related to the recognition of foreign income under the transition tax) from the carryback period. Although the limited waiver does not extend the five-year carryback period, it does ensure that a taxpayer is not forced to use an NOL in such a tax year (likely the 2017 or 2018 tax years) where the NOL would merely reduce outstanding tax liability under Section 965, as opposed to producing a near-term cash refund. Note that, for taxpayers who elected to pay Section 965 tax over installments and still have payments due, any refund amount from NOLs carried back from a Section 965 inclusion year will be first credited against installments prior to being returned to the taxpayer.
The carryback election for an NOL arising in a taxable year beginning in 2018 or 2019 must be made by the due date (including extensions) for filing the taxpayer’s return for the first taxable year ending after the date of enactment of the CARES Act, which was March 27, 2020.
It should be noted that new Section 172(b)(1)(D)(iv) as added by the CARES Act provides that if a taxpayer does carryback an NOL to a Section 965 inclusion tax year, the taxpayer will be treated as having made an election under Section 965(n) with respect to such tax year. The effect of such an election is that the Section 965 inclusion is not factored into the determination of the utilization of the NOL in the tax year. This can benefit a taxpayer who may have preferred to utilize a foreign tax credit to reduce Section 965 liability as opposed to an NOL.
It is recommended to consult a member of FGMK’s international tax team to closely review any tax year in which there is a Section 965 inclusion amount and its impact on the NOL carry back. An NOL carryback can also affect other tax attributes, e.g. foreign tax credits that may expire without utilization if “freed-up” due to an NOL carryback. Please see the FGMK International Tax Alert: CARES Act NOL Modifications Impact on Foreign Tax Credits for further discussion.
Filing for Refund Claims
Taxpayers should also consider the potential avenues for claiming a tax benefit from an NOL carryback. While amended return filings provide an option, the length of time for processing an NOL refund through such a process may not provide the necessary immediate liquidity. Therefore, taxpayers should consider the use the filing an application for a tentative carryback adjustment via Form 1139 (corporation) or Form 1045 (non-C corporation), which the IRS must process within 90 days of receipt.
The CARES Act explicitly provides that fiscal-year-end taxpayers with a tax year beginning before January 1, 2018 and ending after December 31, 2017, may file a tentative refund claim if filed within 120 days from the date of enactment of the CARES Act. The due date, which is July 27, 2020, also applies to such tax year for the election to waive the carryback period (two-year limitation as a tax year beginning before January 1, 2018) and application to a Section 965 inclusion tax year, as well as to revoke any prior election made to forgo any carryback of such NOL.
Following the passage of the CARES Act, the IRS released Revenue Procedure 2020-24 and Notice 2020-26 which provided additional guidance. Rev. Proc. 2020-24 provides the procedures for filing a Form 1139 or Form 1045 tentative carryback claim for fiscal year taxpayers who have a tax year beginning before January 1, 2018 and ending after December 31, 2017, as allowed by the CARES Act. The revenue procedure also provides guidance for taxpayers who seek to elect to:
A taxpayer may elect the former by attaching an election statement (separate statement for each tax year) to its income tax return for the first tax year ending after March 27, 2020. The latter election may be made for the 2018 or 2019 tax years by again filing an election statement to its income tax return for the first tax year ending after March 27, 2020. For an NOL arising in a tax year beginning after December 31, 2019 and before January 1, 2021 (i.e. 2020 tax year), the latter election must be made no later than the due date (including extensions) for the filing of the income tax return for the tax year in which the NOL arises.
Notice 2020-26 allows taxpayers who have NOLs arising in a tax year beginning on or after January 1, 2018 and ending before June 30, 2019 to file an application for a tentative carryback adjustment via a Form 1139 or Form 1045 if filed by June 30, 2020. This extension provides relief that was absent in the CARES Act.
If you have NOLs and would like to monetize the value of such tax attributes, please contact your FGMK engagement team.
The summary information in this document is being provided for education purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.
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