On July 2, 2020, the U.S. Internal Revenue Service (the IRS) and the U.S. Treasury Department ("Treasury") promulgated temporary regulations under section 1502 of the Internal Revenue Code of 1986, as amended (T.D. 9900) (the "Code,"1 and such regulations, the "Temporary Regulations") regarding waivers of consolidated net operating loss (CNOL) carrybacks.2 The Temporary Regulations allow a consolidated group (the "acquiring consolidated group") that acquires a member (the "acquired member") from another consolidated group (the "former consolidated group") to elect to waive the carryback of post-acquisition CNOLs that are properly attributable to the acquired member to a taxable year of the former consolidated group.3 The Temporary Regulations address issues created by the five-year NOL carryback period that was retroactively added by the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act")4
As discussed below in more detail, the Temporary Regulations provide welcome relief to consolidated groups that acquired a member within the past five years and ensure that such consolidated groups do not need to balance (i) losing the portion of a post-acquisition CNOL attributable to an acquired member against (ii) relinquishing the carryback for the entire CNOL generated by the consolidated group by making the general waiver election set forth in section 1.1502-21(b)(3)(i) of the Treasury regulations as further described below.5 Consolidated groups looking to rely on the elections set forth in the Temporary Regulations for CNOLs arising in 2018 and 2019 taxable years should pay close attention to the November 30, 2020 deadline for filing an amended tax return that includes either of the split-waiver elections set forth in the Temporary Regulations.
Changes to NOL Carryback Rules under the TCJA and the CARES Act
Prior to the Tax Cuts and Jobs Act (the TCJA),6 corporations could carryback net operating losses (NOLs) for two years to obtain a refund for the overpayment of taxes in such years and carryforward their NOLs for 20 years to offset taxable income, if any, in future taxable years. The TCJA amended section 172 to generally prohibit the carryback of NOLs arising in taxable years beginning after December 31, 2017. However, the CARES Act retroactively amended section 172 to require that NOLs generated in taxable years beginning after December 31, 2017, and before January 1, 2021 be carried back to each of the five taxable years preceding the taxable year in which the NOL was generated, unless the taxpayer made an irrevocable election under section 172(b)(3) to waive the NOL carryback period.7 In the absence of a valid waiver of a NOL carryback to one or more taxable years, NOLs are first carried back to the earliest taxable year to which they may be carried.
Existing Treasury Regulations
Section 1.1502-21(b)(1) of the Treasury regulations provides that CNOLs must be carried over or carried back to taxable years under the principles of section 172 and section 1.1502-21 of the Treasury regulations. Section 1.1502-21(b)(2)(i) of the Treasury regulations provides that, unless the acquiring consolidated group makes the general waiver election or split waiver election described below, if any portion of a CNOL attributable to an acquired member may be carried back to a separate return year of the acquired member, such portion of the CNOL must be so carried subject to the separate return limitation year rules set forth in section 1.1502-21(c) of the Treasury regulations. For these purposes, a separate return year includes a taxable year in which the acquired member was a member of its prior consolidated group. The portion of any CNOL carried back to a separate return year of an acquired member may not be carried back to an equivalent, or earlier, consolidated return year of the acquiring consolidated group.
The existing Treasury regulations allow only two types of elections with respect to CNOLs generated by an acquiring consolidated group. First, section 1.1502-21(b)(3)(i) of the Treasury regulations permits any consolidated group to make an irrevocable election under section 172(b)(3) to relinquish the entire carryback period with respect to the entire CNOL of the acquiring consolidated group arising in a particular taxable year (the "General Waiver Election"). The General Waiver Election cannot be made solely with respect to the portion of a CNOL attributable to a single member but must be made for the entire consolidated group for a given year. Second, section 1.1502-21(b)(3)(ii)(B) of the Treasury regulations permits an acquiring consolidated group to make an irrevocable election to waive, with respect to the portion of a CNOL that is attributable to the acquired member, the portion of the CNOL carryback period for which the acquired member was a member of the former consolidated group (the "Split-Waiver Election"). The acquiring consolidated group is required to make the Split-Waiver Election by attaching a separate statement to its original U.S. federal income tax return for the taxable year that includes the acquisition. Accordingly, if the Split-Waiver Election is not made with the original U.S. federal income tax return for the taxable year of the acquisition, the acquiring consolidated group cannot subsequently make the Split-Waiver Election made by amending its U.S. federal income tax return for such taxable year. However, it may be possible to request a private letter ruling permitting the Split-Waiver Election to be filed late if the requirements of section 301.9100–3 of the Treasury regulations are satisfied.
Unintended Consequences Created by the CARES Act NOL Carryback Rules
Split-Waiver Elections were common in pre-2018 taxable years because the portion of a CNOL attributable to an acquired member, could be carried back for two taxable years under pre-TCJA law. Pre-TCJA purchase agreements commonly contained covenants requiring acquiring consolidated groups to make such elections, but such elections were rarely made after 2017 because the TCJA eliminated almost all NOL carrybacks. Because the CARES Act allows NOLs generated in 2018, 2019 and 2020 to be carried back, the Split-Waiver Election has once again become relevant. Unfortunately, the existing consolidated return Treasury regulations do not protect acquiring consolidated groups that did not make the Split-Waiver Election on their original U.S. federal income tax returns for 2018 and 2019 when section 172 did not permit the carryback of NOLs.
Accordingly, prior to the Temporary Regulations, an acquiring consolidated group, that did not make the Split-Waiver Election on its original U.S. federal income tax return for the year of the acquisition, was faced with the decision of either (i) making the General Waiver Election to waive the entire carryback period with respect to a CNOL generated in a particular taxable year or (ii) carrying back the entire CNOL, with the result that the portion of the CNOL attributable to an acquired member, would be available to the former consolidated group. Carrying back the entire CNOL of the acquiring consolidated group, would typically result in any tax refunds being received by the parent of the former consolidated group, unless the purchase agreement, or other contract, required the refund to be paid over to the acquiring consolidated group.8 Thus, to avoid surrendering the portion of a CNOL attributable to the acquired member to its former consolidated group, acquiring consolidated groups were compelled to make the General Waiver Election. This could prevent the acquiring consolidated group from carrying back any portion of its CNOL for the taxable year and waive the right to a needed tax refund.
Another unintended consequence of the CARES Act's extension of the carryback period arises where the purchase price paid by the acquiring consolidated group for the acquired member, took into account the estimated value of the portion of the former consolidated group's 2018 and/or 2019 CNOLs attributable to the acquired member. The retroactive reach of the changes to the NOL carryback rules under the CARES Act can frustrate the parties' expectation that the acquiring consolidated group will benefit from the carryforward of such portion of the former consolidated group's CNOL by causing the 2018 and 2019 CNOLs, attributable to the acquired member, to be completely or partially carried back to the prior taxable years of the former consolidated group, unless the former consolidated group files the General Waiver Election.
The Temporary Regulations
To ensure that acquiring consolidated groups that failed to make the Split-Waiver Election for the taxable year that included the acquisition date of an acquired member are not forced to decide between losing the benefit of the portion of a CNOL attributable to an acquired member and waiving the acquiring consolidated group's entire CNOL carryback, the Temporary Regulations provide two additional split-waiver elections. An acquiring consolidated group can make these split-waiver elections if it (i) acquired a member before the CARES Act extended the NOL carryback period under section 172 and (ii) has CNOLs attributable to an acquired member that are eligible to be carried back to one or more taxable years of the former consolidated group.
However, the Temporary Regulations do not provide relief to acquiring consolidated groups that assigned value to the portion of the former consolidated group's 2018 and 2019 CNOLs that were attributable to the acquired member in instances in which the former consolidated group utilized such CNOLs as a result of the CARES Act's retroactive extension of the NOL carryback period.
Amended Statute Split-Waiver Election
The first election provided for under the Temporary Regulations is the "Amended Statute Split-Waiver Election." The Amended Statute Split-Waiver Election is made annually and permits an acquiring consolidated group to make an irrevocable election to waive the carryback of CNOLs attributable to the acquired member arising in a particular post-acquisition year to any taxable year of the former consolidated group. In the future, the acquiring consolidated group and the former consolidated group should include covenants in purchase agreements governing whether the acquiring consolidated group will make any Amended Statute Split-Waiver Elections, even if section 172, as in effect at the time of the acquisition, does not allow for the carryback of NOLs.
Extended Split-Waiver Election
The second election provided for under the Temporary Regulations is the "Extended Split-Waiver Election." The Extended Split-Waiver Election is similar to the Amended Statute Split-Waiver Election, but permits an acquiring consolidated group to make an irrevocable election to waive the carryback of post-acquisition CNOLs attributable to the acquired member to any taxable year(s) of the former consolidated group within the "extended carryback period" (i.e., just the additional taxable years added to the CNOL carryback period that was in effect at the time of the acquisition). An Extended Split-Waiver Election does not prevent CNOLs from being carried back to taxable years of the former consolidated group that were within the CNOL carryback period before the applicable statutory amendment extending the NOL carryback period.9
Procedures for Making the Amended Statute Split-Waiver Election & Extended Split-Waiver Election
The Amended Statute Split-Waiver Election and Extended Split-Waiver Election may only be made if the NOL carryback period under section 172 was extended by a statutory amendment that occurs after the date of the acquisition of the acquired member.
The Temporary Regulations provide that the Amended Statute Split-Waiver Election and the Extended Split-Waiver Election are made by attaching a statement to the acquiring consolidated group's timely filed (including extensions) tax return for the taxable year in which the applicable CNOL was incurred.10 If the date for the timely filing of the acquiring consolidated group's U.S. federal income tax return for the taxable year in which the CNOL was incurred is less than 150 days after the date of the statutory amendment extending the NOL carryback period, then the Amended Statute Split-Waiver Election or the Extended Split-Waiver Election, as the case may be, can be made on or before the date that is 150 days after the date of the statutory amendment. As a result, for CNOLS that arose in 2018 or 2019, these waivers must be filed by November 30, 2020.11
The Amended Statute Split-Waiver Election and the Extended Split-Waiver Election are only valid if any other corporation joining the acquiring consolidated group that was affiliated with the acquired member immediately before the acquired member joined the acquiring consolidated group, is included in the Amended Statute Split-Waiver Election or the Extended Split-Waiver Election.
The Amended Statute Split-Waiver Election and the Extended Split-Waiver Election can only be made if the carryback of the CNOL is not claimed on a return or other filing by the former consolidated group before the date on which the acquiring consolidated group files the Amended Statute Split-Waiver Election or the Extended Split-Waiver Election.12
Finally, the Amended Statute Split-Waiver Election cannot be made if the acquiring consolidated group filed a valid General Waiver Election for the taxable year in which the CNOL was incurred or filed a valid Split-Waiver Election with respect to the acquired member.
Effective Date of Temporary Regulations
The Temporary Regulations apply to any CNOLs arising in a taxable year ending after July 2, 2020. Taxpayers may apply the Temporary Regulations to any CNOLs generated in taxable years beginning after December 31, 2017. However, the Temporary Regulations will expire on July 3, 2023 unless they are issued as final regulations.
Footnotes
1. Unless otherwise indicated, all "section" references contained herein are to sections of the Code.
2. Section 1.1502-21(e) of the Treasury regulations defines a CNOL as "[a]ny excess of deductions over gross income, as determined under [section 1.1502-11(a) of the Treasury regulations] (without regard to any CNOL deduction)."
3. Although beyond the scope of this publication, on July 2, 2020, the IRS and Treasury also promulgated proposed regulations under section 1502 (REG-112339-19) that provide guidance to consolidated groups regarding the application of certain amendments to section 172 that were made by the CARES Act and the Tax Cuts and Jobs Act.
4. Pub. L. No. 116-136.
5. Section 1.1502-21(a) of the Treasury regulations provides that the CNOL deduction for any consolidated return year as the aggregate of the NOL carryovers and carrybacks to the year, which consist of (i) any CNOLs of the consolidated group and (ii) any NOLs of the group's members arising in separate return years.
6. Pub. L. No. 115-97.
7. Any election to waive the carryback period must be made by the due date (including extensions of time) for filing the taxpayer's tax return for the taxable year of the NOL for which the election is to be in effect. The deadline to waive the carryback period for NOLs arising in a taxable year beginning in 2018 or 2019 is the extended due date for filing the taxpayer's tax return for its first taxable year ending after March 27, 2020. Elections to forgo or reduce the carryback of NOLs arising in taxable years which began before January 1, 2018 and ended after December 31, 2017 must be made no later than July 27, 2020. See Section 172(b)(1)(D)(v)(II); Rev. Proc. 2020-24, 2020-18 I.R.B. 750
8. It is common that purchase agreements provide that a purchaser is prohibited from carrying back losses from a post-acquisition period to a consolidated tax return of the former consolidated group, and if a loss is carried back to the former consolidated group, any refunds arising from such carryback are to be retained by the former consolidated group. Due to the potential carryback of losses for state and foreign tax purposes, purchase agreements entered into post-2017 often continued to contain such provisions. Furthermore, even if the purchase agreement is silent as to the person that is entitled to receive the refund, section 1.1502-77(d)(5) of the Treasury regulations provides that the agent of the former consolidated group must file the claim for refund and will be paid the refund by the IRS. Therefore, as a practical matter, to the extent that a CNOL of the acquiring consolidated group is carried back to a tax return of the former consolidated group, the agent of the former consolidated group will receive the refund and generally will have no legal obligation to pay-over the refund to the acquiring consolidated group.
9. The carryback of NOLs incurred in 2018, 2019 and 2020 was generally prohibited for taxable years beginning after December 31, 2017 prior to the enactment CARES Act. Thus, either the Amended Statute Split-Waiver Election or the Extended Split-Waiver Election should have the same result in the context of any NOLs generated in 2018, 2019 and 2020.
10. The Amended Statute Split-Waiver Election and the Extended Split-Waiver Election are made on a year-by-year basis, regardless of whether such elections are made with respect to the portion of the CNOL attributable to the acquired member in other taxable years.
11. Most acquiring consolidated groups have not yet filed their 2019 U.S. federal income tax returns and are therefore eligible to make the Split-Waiver Election with respect to any member acquired in 2019. However, if the acquiring consolidated group's 2019 U.S. federal income tax return has already been filed, the acquiring consolidated group may make the Amended Statute Split-Waiver Election and the Extended Split-Waiver Election by filing an amended 2019 U.S. federal income tax return by November 30, 2019
12. In order to preserve the ability to make the Amended Statute Split-Waiver Election and the Extended Split-Waiver Election, acquiring consolidated groups should consider adding language to the applicable purchase agreement expressly prohibiting the former consolidated group from filing a claim for refund with respect to the portion of a CNOL attributable to an acquired member.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
