CARES Act delivers five-year NOL carryback to aid corporations

Introduction

The Coronavirus Aid, Relief and Economic Security Act (the CARES Act or the Act) is a comprehensive plan that will affect the vast majority of US businesses and their employees. Among many other items, the Act provides four relief provisions for corporate taxpayers as follows:

1. Five-year net operating loss (NOL) carryback provision;
2. Fiscal year NOL carryback fix from the Tax Cuts and Jobs Act (TCJA) of 2017;
3. Deferral of 80% income limitation on post-2017 NOLs to 2021;
4. Immediate AMT tax credit refunds.

For many corporate taxpayers the five-year carryback provision is the largest benefit.

What tax years are eligible for the five-year carryback?

The Act amends section 172(b) to allow for the carryback of losses arising in a taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2021, to each of the five taxable years preceding the taxable year of the loss. For calendar year taxpayers that generally means NOLs incurred in tax years ending Dec. 31, 2018, 2019 and 2020 are eligible for a five-year carryback. Moreover, the carryback provision allows a corporation to carryback NOLs to taxable years for which the corporate tax rate was 35% (periods prior to 2018), as compared to the current 21% rate. An added benefit exists since the corporate equity reduction transaction rules of section 172(h) were repealed with the TCJA, meaning it is more likely that the full amount of NOLs should be available for the five-year carryback.

The Act provides a special rule for filing a carryback claim for the 2018 tax year (and certain fiscal or short-tax years), which will deem a carryback claim timely filed if it is filed no later than 120 days after the enactment of the Act.

Understanding the five-year carryback period

To accurately estimate the carryback potential, corporations need to understand how the carryback may impact the tax years to which the NOLs will be carried. Perhaps most important is understanding to which tax year the NOL is being carried back. The existence of short tax years can lead to unexpected results. Consider the following example.

Example 1: Corporation X incurs a loss in 2019 that it intends to carry back. However, Corporation X had two tax years ending in 2018 due to a change from a June 30 fiscal year to calendar year. The 2019 NOL is carried back to years ending:

1. Dec. 31, 2018
2. June 30, 2018
3. June 30, 2017
4. June 30, 2016
5. June 30, 2015

Any NOL incurred in the June 30, 2018 year is not eligible for carryback as the year began July 1, 2017. Any NOL incurred in the Dec. 31, 2018 year is only carried back as far as June 30, 2014.

Short years resulting from M&A transactions can create similar unexpected results. Consider the following examples.

Example 2: Assume that Corporation X was a stand-alone calendar year C corporation acquired June 30, 2018 by Corporation P. Corporation P is strictly a holding company and the two corporations elected to file a consolidated return. In 2019, the P-X group has a loss, all attributable to X, that they wish to carry back. The loss is carried back to the years ending:

1. Dec. 31, 2018 (P-X consolidated return)
2. June 30, 2018 (X stand-alone return)
3. Dec. 31, 2017 (X stand-alone return)
4. Dec. 31, 2016 (X stand-alone return)
5. Dec. 31, 2015 (X stand-alone return)

Example 3: Assume that X incurred a $100 loss in 2018 and that the loss was ratable between the two short periods ending June 30, 2018 and Dec. 31, 2018. Assume further that X generated $100 of income in the tax year ending Dec. 31, 2013. If it were not for the short tax year in 2018, X would carry back the full $100 loss to the Dec. 31, 2013 year. Unfortunately, only the $50 loss from the June 30, 2018 return is eligible for carryback to Dec. 31, 2013, but is eligible to be carried back to the years ending:

1. Dec. 31, 2017 (X stand-alone return)
2. Dec. 31, 2016 (X stand-alone return)
3. Dec. 31, 2015 (X stand-alone return)
4. Dec. 31, 2014 (X stand-alone return)
5. Dec. 31, 2013 (X stand-alone return)

An additional complication arises where the corporation incurring a loss was part of a separate consolidated group in a carryback year. In this situation, the common parent of the old group generally needs to file a carryback claim. In addition, the common parent of the old group receives the actual refund, so the parties would need to come to some sort of agreement as to what happens to the refund and whether the common parent of the old group must cooperate.

Example 4: Consider a slight change to the facts of Example 3 and assume X was a part of a consolidated return for which Z was the common parent. To receive a refund, Z will need to file the carryback claim to the Dec. 31, 2013 tax year and Z will receive the refund. If the parties are unable to come to an agreement as to the refund, legal steps may be necessary to determine who benefits from the refund.

Example 5: Assume the same facts as Example 4 except that the Z group was in a consolidated loss in 2013 despite X having $100 of taxable income. In this case, no carryback from the 2018 year is available as the Z group was in an overall loss.

Another complication as to benefiting from the carryback may occur due to an M&A transaction. In many situations the parties agreed to the treatment of tax refunds and liabilities based upon existing law that did not allow NOL carrybacks. Creation of the NOL carryback could result in prior owners having a claim to the refunds, which is not the intent of the Act.  As a result, it is critical that parties to an M&A transaction determine whether there is anything in the transaction documents that clarifies who has the right to the refund.

Based upon the above examples, the first step in the analysis is to get a clear picture of available carryback years and the party benefiting from the carryback. Once the taxpayer determines the applicable tax years for the carryback, it is important to evaluate how the NOL carryback affects the taxable year to which it is being carried.

Understanding the interplay of the five-year carryback and other provisions

The Act also addresses the interaction between the new carryback rule and the section 965 transition tax, and makes clear that a taxpayer cannot use the carrybacks to offset section 965 income. The Act provides that if a taxpayer elects to carry back NOLs to a taxable year in which the taxpayer had section 965 income, then the taxpayer is treated as having made a section 965(n) election not to use NOLs to offset the section 965 income amount. However, the Act allows a taxpayer to elect to exclude from its NOL carryback any taxable year to which section 965 applies.

In addition, the carryback of NOLs can impact credits and deductions the corporation had previously claimed. Some of the provisions that should be considered are:

• The section 199 domestic production activities deduction (DPAD) (repealed for tax years beginning after Dec. 31, 2017). This deduction is limited to taxable income, so an NOL carryback could reduce the DPAD deduction previously claimed.
• The Section 179 election to expense depreciable assets (which may not exceed the aggregate amount of taxable income). This deduction is limited to taxable income, but the excess generally is carried forward to subsequent tax years.
• The section 250 deduction (limited to 50% of taxable income after NOL) relating to global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) deductions (not available prior to 2018).
• The charitable contribution deduction under section 170(b)(2)(A) (limited to 10% of taxable income). To the extent reduced, this charitable deduction is carried forward.
• General business credits (nonrefundable, generating a 20-year credit carryforward). The carry back of an NOL may reduce a current year credit that had been claimed, and increase a credit carryforward that the taxpayer may be able to use in future tax years.

Fiscal year NOL carryback fix

The Act adds a welcome technical correction for fiscal year taxpayers that was overlooked in the TCJA. The TCJA provided for an odd result for fiscal year corporations reporting an NOL for a tax year that includes December 31, 2017 and ends after December 31, 2017. For example, under a plain reading of the statute, a corporate taxpayer projecting an NOL for a fiscal year ending March 31, 2018 appeared subject to the NOL carryback disallowance because the tax year ended after December 31, 2017. The Act corrects the language to provide fiscal year taxpayers who had NOLs arising in years that began prior to December 31, 2017 and ended after December 31, 2017 with the ability to carry back those NOLs.

Deferral of the 80% taxable income limitation

The Act makes modifications to the rules of section 172(a) previously enacted in the TCJA. The TCJA enacted a limitation on the amount of NOLs that a corporation may deduct in a single tax year under section 172(a) equal to the lesser of the available NOL carryover or 80%of a taxpayer’s pre-NOL deduction taxable income (the ‘80% limitation’).

The Act suspends this 80% limitation for taxable years beginning before Jan. 1, 2021, and instead allows the full offset of taxable income. For tax years beginning after Dec. 31, 2020, the Act reinstates the 80% limitation.

Alternative minimum tax credit refunds

The Act accelerates the payment of alternative minimum tax (AMT) credit refunds to corporations. Corporations with AMT credit carryforwards may be able to claim tax refunds under these new rules.

Congress previously repealed the corporate AMT for taxable years beginning after Dec. 31, 2017. Where a corporation has an AMT credit from a prior taxable year, the corporation is permitted to use it as a refundable tax credit. Prior to the Act, the Code provided a schedule for carrying an unused AMT credit forward and permits portions of the credit to be used in each taxable year beginning after 2017 but before 2022. 

The Act accelerates availability of these AMT credits. The full remaining refundable AMT credit amount will be available for a corporation’s first taxable year beginning in 2019. Alternatively, a corporation may elect to use 100% of its AMT credits for its first taxable year beginning in 2018. 

Takeaways

The CARES Act provides a myriad of programs to assist businesses and employees hurt by the current crisis. From a federal income tax perspective, the five-year NOL carryback provisions for corporate taxpayers should provide much needed liquidity. As a result of some of the complexities discussed above, corporations should consult with their tax advisors when performing carryback-related computations.