Explanation clarifies intent of 80 percent rule to pre-2018 NOLs
The Joint Committee on Taxation’s recent release of its general explanation (known as the “Blue Book”) of the Tax Cuts and Jobs Act (“TCJA”) helps shed light on Congress’s intent in enacting various provisions. Although the explanations found in the Blue Book do not constitute official legislative history, they are helpful interpretation. One of the items addressed in the Blue Book is the application of the new limitation on net operating loss (“NOL”) deductions when also utilizing NOLs arising from years prior to 2018.
The TCJA contains several changes related to the availability of NOLs to offset taxable income, and chief among them is a new rule that limits the NOL deduction to 80 percent of taxable income. Under this change, losses arising in taxable years beginning after Dec. 31, 2017, may offset no more than 80 percent of taxable income. Carryovers of such NOLs to other years may be carried over indefinitely.
The TJCA and accompanying regulations do not explain how a taxpayer with NOLs carrying over from both taxable years beginning before 2018 (‘‘pre-2018’’) and after 2017 (‘‘post-2017”) must apply the 80 percent rule when offsetting taxable income arising in post-2017 years. Does the 80 percent limitation apply to the taxpayer’s total taxable income? Or does the limitation only apply to the taxable income not used to offset the pre-2018 NOL carryovers?
The Blue Book takes the latter approach, which is more taxpayer friendly. Under the Blue Book’s interpretation, the NOL deduction should be computed in two stages: First, the taxpayer can offset taxable income by its pre-2018 NOL carryovers, without limitation. Second, the taxpayer can offset 80 percent of the remaining taxable income (income not offset in the first stage) by its post-2017 NOL carryovers (up to the amount of available NOLs).
The following example can serve as an illustration. A taxpayer has $120 of pre-2018 NOL carryovers and $70 of post-2017 NOL carryovers. In 2019, the taxpayer has $200 of taxable income. Under the Blue Book’s interpretation, the taxpayer is entitled to an NOL deduction equal to the sum of (i) its pre-2018 NOL carryovers and (ii) 80 percent of its remaining 2019 taxable income (up to the amount of NOLs available). Accordingly, the taxpayer’s NOL deduction is (i) $120 plus (ii) 80 percent of the taxpayer’s remaining taxable income, or $64 (80 percent of $80 ($200 taxable income less the $120 offset by the pre-2018 NOL carryovers)). Thus, for 2019, the taxpayer is entitled to an NOL deduction of $184 ($120 plus $64). The taxpayer will have $6 ($70 minus $64) of post-2017 NOL carryovers that will carry over to 2020.
Under the alternative approach, the taxpayer is limited to an NOL deduction of 80 percent of its total taxable income when offsetting the post-2017 NOL carryovers. Accordingly, in regard to the post-2017 NOL carryovers, the taxpayer’s NOL deduction is limited to $160 (80 percent of $200), which offsets its $120 pre-2018 NOL carryovers plus $40 of its post-2017 NOL carryovers. The taxpayer will have $30 ($70 minus $40) of post-2017 NOL carryovers that will carry over to 2020.
The Bluebook notes that a technical correction may be necessary to reflect the above intent of Congress. The question facing taxpayers and advisors is whether, without a technical correction or regulatory fix, a taxpayer is able to get comfortable taking the more favorable position. Taxpayers should seek tax advice on this issue prior to taking a position on NOL utilization.