Temporary and proposed regulations for consolidated groups of corporations that apply net operating loss (NOL) carrybacks and carryovers have been published by Treasury Department and the IRS. The proposed regulations provide NOL guidance for consolidated corporate groups in light of the NOL rules enacted in December 2017 as part of the Tax Cuts and Jobs Act (the TCJA) and in March 2020 as part of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). The proposed regulations are particularly relevant to consolidated corporate groups accounting for any of the following:
- The 80% taxable income limitation for NOL deductions enacted in the TCJA and deferred by the CARES Act,
- NOLs of groups including both nonlife insurance companies (Property and Casualty Insurance Companies, or P&C Companies) and other corporations,
- Special status losses (such as farming corporation losses), or
- Separate return limitation year limitations (SRLYs).
This Alert discusses those Proposed Regulations (Notice of Proposed Rulemaking, REG-125716-18, 85 Fed. Reg. 40927 (July 8, 2020)). We discuss the new temporary regulations (T.D. 9900 (July 8, 2020)) in another Alert.
The 80% NOL deduction limitation in consolidated groups
The TCJA enacted a limitation on the amount of NOLs that a corporation may deduct in a single tax year. The limitation amount is equal to the lesser of the available NOL carryover or 80% of a taxpayer’s pre-NOL deduction taxable income (the 80% Limitation). The CARES Act suspended the 80% Limitation for taxable years beginning before Jan. 1, 2021, instead allowing the full offset of taxable income, and also clarified the 80% Limitation computation under certain circumstances. The 80% Limitation now applies to tax years beginning after Dec. 31, 2020. For additional discussion of the CARES Act’s changes to the NOL rules, see our prior Alert CARES Act delivers five-year NOL carryback to aid corporations.
The proposed regulations address how the 80% Limitation should be applied within a consolidated group. The Proposed Regulations state that a consolidated group must determine its 80% Limitation amount with respect to consolidated NOLs (CNOLs) for taxable years beginning after Dec. 31, 2017 (post-2017 years) based upon its consolidated taxable income and the aggregate amount of pre-2018 CNOLs from taxable years beginning before Jan. 1, 2018 (pre-2018 years) carried to the tax year. To determine the amount of NOL available to offset taxable income where the 80% Limitation applies, the proposed regulations indicate that the corporate group first deducts pre-2018 NOLs without limit. Next, the taxpayer deducts post-2017 NOLs up to 80% of the taxpayer’s taxable income (computed without regard to the deductions under sections 172, 199A, and 250) determined after the deduction of pre-2018 NOLs.
Application of the 80% Limitation in mixed groups
The 80% Limitation does not apply to P&C Companies. The proposed regulations provide guidance for consolidated groups are made up of both at least one P&C Company and at least one corporation that is not a P&C company (Mixed Groups).
Applying the 80% Limitation to a Mixed Group is fairly straightforward if there are no pre-2018 NOLs and the Mixed Group’s P&C Companies all have positive income before the CNOL deduction. However, if the non-P&C Company corporate member taxable income pool is positive, the P&C Company taxable income pool is negative, and the Mixed Group has positive taxable income before the application of the NOL rules, the calculation and application of the 80% limitation is more complicated. In that fact pattern, the proposed regulations provide that the post-2017 CNOL deduction limit is determined by applying the 80% Limitation to the combined income of the mixed group.
However, if the facts were different, such that the Mixed Group had positive combined taxable income, but the income is generated by P&C Companies rather than by the non-P&C Company members of the Mixed Group, the 80% Limitation would be equal to the income of the Mixed Group, determined without regard to the 80% Limitation. That result under the Proposed Regulations is driven by the fact that in that situation the amount of income to be offset is defined by the P&C Company taxable income pool rather than the non-P&C Company taxable income pool.
If the mixed group has a pre-2018 NOL, the calculation becomes less clear. The proposed regulations provide an example to illustrate the conundrum:
If the consolidated group carried $50 of pre-2018 NOL and $1000 of post-2017 NOLs forward into 2021, and in 2021 the non-life insurance company members and corporate members each earn $100 of income, what would the result be? If the pre-2018 NOL solely reduced the corporate member pool of $100, the limitation on the post-2017 NOL would be $100 (related to the non-life insurance income not subject to the 80% Limitation) plus 80% of $50 (the non-P&C Company income not offset by pre-2018 NOL), or a total of $140. If instead, the pre-2018 NOL solely reduced the P&C Company taxable income pool, the limit would instead be $50 (the P&C Company taxable income offset by pre-2017 NOL) plus 80% of $100 (the non-P&C Company taxable income for 2021), or $130.
To cure this ambiguity, the Proposed Regulations apply the pre-2018 NOLs pro-rata to the P&C Company taxable income pool and the non-P&C Company taxable income pool in proportion to their current year income. Again applying the facts above, the pre-2018 NOL would be allocated half to the P&C Company taxable income pool and half to the non P&C Company taxable income pool, $25 and $25. Thus, the post-2017 deduction limit would be the $100 of P&C Company taxable income pool less $25 of pre-2018 NOL ($75), plus 80% of the remaining non-P&C Company taxable income pool after offsetting for pre-2018 NOL (80% of $75), for a total of $135.
Separate return limitation year (SRLY) rules
The SRLY rules generally treat certain acquired or departing members of a consolidated group as separate filers for purposes of utilizing NOLs and certain other corporate tax attributes. In the case of a member joining a consolidated group, the SRLY rules measure the new member’s contribution to consolidated taxable through a ‘SRLY register,’ which tracks the SRLY member’s net positive (or negative) contribution to the income of the group. See generally Reg. section 1.1502-21(c)(1)(i). Prior to release of the proposed regulations, it was unclear how to account for the SRLY register when a SRLY member’s NOLs are used to offset consolidated taxable income in a year subject to the 80% Limitation.
The proposed regulations address maintenance of the SRLY register where the 80% Limitation applies. They provide that the SRLY register is reduced by the full amount of income needed to support the NOL deduction, and not merely the 80% of taxable income offset where the 80% Limitation applies. Said differently, a SRLY member would need to $100 of taxable income to enable the group to absorb $80 of the SRLY member’s SRLY limited post-2017 NOLs. Thus, upon the group’s deduction of $80 of NOL of the SRLY member, the cumulative register would be reduced by the full $100.
Other CNOL Issues
The proposed regulations re-propose in modified form regulations proposed in 2015 that would require a consolidated group to recompute the percentage of the CNOL allocable to its members when a member’s portion of a CNOL is absorbed or reduced on a non-pro rata basis. These rules could apply to the extent a CNOL attributable to a P&C Company is carried back (and reduced) under the amendments enacted by the TCJA, while the remaining portion of the CNOL allocable to other members is not similarly reduced.
The Proposed Regulations also modify regulations proposed in 2012 that would provide for the allocation of special status losses to each group member with a loss regardless as to whether the member undertakes the activities that generate the special status losses. This rule is particularly relevant to corporate groups with farming losses.
Farming losses, like losses of P&C Companies, generally may be carried back to the two years preceding the year in which they arose. The general rule provided in the TCJA for NOLs – i.e., for Non-P&C Companies’ non-farming NOLs, is that no carrybacks are permitted. The CARES Act, however, superseded this general rule and generally permits carrybacks for a period of five years for NOLs arising in tax years beginning after Dec. 31, 2017 and before Jan. 1, 2021.
The Proposed Regulations add some welcome clarity to the application of NOL provisions of the TCJA and the CARES Act to consolidated return filers. Given the general complexity of the consolidated return rules, corporate taxpayers should consult with their tax advisors when applying these rules.