NOL Changes and Opportunities in the CARES Act and Revenue Procedure 2020-24
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In order to get cash into the hands of taxpayers during the international pandemic caused by COVID-19, Congress enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136. New guidance may provide beneficial net operating loss (NOL) carryback planning opportunities. Specifically, the CARES Act made several changes to the NOL rules under Section 172 of the Internal Revenue Code (the Code) and related provisions, including a temporary repeal of the 80% limitation for NOLs and a five-year carryback period. The IRS recently issued guidance providing procedures for carrying back NOLs and a six-month extension for Forms 1139 and 1045 filers with respect to NOLs under the CARES Act. This article provides an overview of the changes to NOL carryback rules from the CARES Act and the guidance in IRS Revenue Procedure 2020-24, effective April 9, 2020. See Coronavirus Aid, Relief, and Economic Security Act or the “CARES Act” (H.R. 748) for other tax provisions of the CARES Act.
Overview of the CARES Act and IRS Guidance
Under the Tax Cuts Job Act (TCJA) of 2017, the ability to use NOLs to offset taxable income was limited to 80% of a taxpayer’s taxable income for NOLs arising in tax years beginning after December 31, 2017. Additionally, the NOL carryback rules were repealed for NOLs arising in tax years beginning after December 31, 2017. The CARES Act provides relief from these limitations. The CARES Act repealed the 80% limitation for tax years beginning before January 1, 2021. CARES Act, P.L. 116-136 § 2303(a)(1). 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. CARES Act, P.L. 116-136 § 2303(d)(1). Under the CARES Act Section 2303(b)(1), a taxpayer can also now carry back NOLs arising in tax years ending after December 31, 2017 and beginning before January 1, 2021 (i.e., 2018, 2019, and 2020) to each of the five preceding tax years. 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. CARES Act, P.L. 116-136 §2303(d)(2).
Rev. Proc. 2020-24 provides guidance to taxpayers with NOL carrybacks under the CARES Act by providing procedures for waiving the carryback period in the case of NOLs arising in a taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2021. In addition, the Rev. Proc. provides rules for waiving a carryback period, reducing a carryback period, or revoking an election to waive a carryback period for a taxable year that began before Jan. 1, 2018, and ended after Dec. 31, 2017.
The first step for a corporate taxpayer looking to waive a carryback under Section 172(b)(3) of the Code, 26 USCS §172(b)(3), is to see if Schedule K, box 11 of Form 1120 (“If the corporation has an NOL for the tax year and is electing to forego the carryback period”) is checked. If so, the carryback has likely already been waived. However, for tax years ending after Dec 31, 2017, while the box was on Form 1120, there was no ability to carry back an NOL in those years, so there is some question as to the efficacy of checking the box. Due to this question, we recommend that tax counsel follow the waiver procedure described below. If the box is blank, the taxpayer has the ability to waive the NOL carryback under Section 172(b)(3) by following Rev. Proc. 2020-24. Under Rev. Proc. 2020-24, a taxpayer can waive the carryback period for an NOL arising in a taxable year beginning in 2018 or 2019. The irrevocable election must be made no later than the due date, including extensions, for filing the taxpayer’s federal income tax return for the first taxable year ending after March 27, 2020 by attaching the election to its federal income tax return. The election statement must state that the taxpayer is electing to apply Section 172(b)(3) under Rev. Proc. 2020-24 and the taxable year for which the statement applies. Note that it is not certain whether the parent of an acquiring consolidated group can act as the agent for an acquired subsidiary when filing a new waiver.
Rev. Proc. 2020-24 provides for a six-month extension of time to file Form 1139, as applicable, with respect to the carryback of an NOL that arose in any taxable year that began during calendar year 2018 and that ended on or before June 30, 2019. If the time to file for a “quickie refund” has passed, even with an extension, the refund will need to be requested via the filing of amended returns.
Certain taxpayers may choose not to carryback an NOL to a year in which Section 965 transition tax was applied. See 26 USCS §965. 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). 26 USCS §965(a). A U.S. shareholder of a DFIC may elect not to take into account the inclusion amount for determining the shareholder’s NOL for the tax year or in calculating the amount of taxable income for the tax year. 26 USCS §965(n). 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). CARES Act, P.L. 116-136 § 2303(b)(1).
If the election is made, instead of relinquishing the entire carryback period, a taxpayer may exclude only the tax years in which Section 965(a) income is included from the carryback period. CARES Act, P.L. 116-136 § 2303(b)(1). 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 a 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. Rev. Proc. 2020-24 also provides that if a carryback claim is filed, a taxpayer may disregard certain amounts of foreign income subject to the Section 965 transition tax that would normally have been included as income during the five-year carryback period.
Planning Points to Consider with the Carryback Claims
The new carryback provisions, importantly, are not 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, because such rules were eliminated in the tax law changes that occurred in 2017. Under prior law, a CERT arose when there was an acquisition of stock or assets essentially by the use of borrowed funds. The CERT rules attempted to limit the attractiveness of such transactions by depriving the acquirer of an immediate carryback refund for its borrowing costs. The TCJA’s repeal of the NOL carryback rules made the CERT rules moot, and thus the CERT rules were repealed as well. 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.
The CARES Act provides new carryback planning and potential opportunities for tax refunds that may be generated from the carryback of NOLs, including, for example, a target company that was acquired after 2017. Before the TCJA, refunds related to transaction year NOL carrybacks were typically addressed in merger agreements. In these situations, sellers would successfully argue that they were entitled to tax refunds from the carryback of losses to pre-closing tax years. After TCJA, transaction year losses would likely 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 pre-TCJA negotiations in their acquisition agreements. For 2018 and 2019 transactions, it may be useful for buyers to review their agreements for any discussion of carrybacks with respect to the target company and who is entitled to any refunds for pre-closing tax years, subject to the consolidated return rules. If warranted, a buyer may be able to obtain a tax refund from a target tax year prior to 2019 if NOLs have been generated by the target company since its acquisition. Many agreements allocate rights with respect to whether buyer or seller is entitled to the benefit of tax refunds and provide procedures, and often constraints, on whether and how to amend previously filed tax returns, as well as how to file tax returns. Tax counsel should conduct a careful review of the relevant acquisition agreements in any planning with regard to these types of NOL carryback claims.