When the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law, taxpayer-friendly opportunities were aimed at quickly getting cash into the hands of businesses who needed it most. One method of accomplishing this included the temporary reintroduction of net operating loss (NOL) carrybacks. While this was certainly a welcomed benefit, some taxpayers who were involved in a merger or acquisition (M&A) in 2018, 2019, or 2020 may need to review their old agreements to make sure the benefits of their NOLs are preserved.
Prior to the enactment of the Tax Cuts and Jobs Act (TCJA) in 2017, corporations with current year NOLs were required to carry back those losses to the previous two tax years (beginning with the earliest year), and any remaining NOL was carried forward to offset future taxable income for 20 years before expiring. However, taxpayers had the ability to make an irrevocable election under Section 172(b)(3) to relinquish the carryback period for those NOLs, making them available for future use only. In an M&A context, this often became a negotiation point when deciding who would receive the tax benefit generated in the preacquisition period, as it is not uncommon for valuable NOLs to arise from transaction-related deductions such as legal fees, bonus payouts, and the vesting of equity compensation.
Decisions on carrying back an NOL can get complex when members are acquired from a consolidated group and join in the filing of a new consolidated group. In a federal consolidated return context, there is no concept of a separate NOL. Each member’s share of income and deductions are combined, offsetting one another; only when the group’s collective deductions exceed income is a single consolidated NOL (CNOL) generated. The CNOL is apportioned to each loss member on a pro rata basis and follows that member if it were to ever leave the group. When a consolidated group carries back an NOL, it is generally required to carry back the entire group’s NOL and does not have the ability to select which losses will or will not be carried back.
When a consolidated group acquires a member from another consolidated group, the acquirer cannot use post-acquisition NOLs attributable to its new member to offset income from a prior period in which it did not own that member. Rather, the portion of the CNOL attributable to the acquired member would potentially only be available to offset the income of its old consolidated group (the seller).
So, what options does a consolidated group have when it has a current-year CNOL to carry back but does not want to permanently lose the tax benefit of the CNOL attributable to its newly acquired member? Preexisting rules gave acquiring corporations two options. One is to make a “general waiver election,” which irrevocably relinquishes the entire NOL carryback period preserving the portion of the acquired corporation’s NOL. However, it would also eliminate the ability of the consolidated group to carry back any of the group’s CNOL. This may not be a good option if the group has a considerable refund opportunity or simply needs the cash. The other option is to make a “split-waiver election” under Treasury Regulation Section 1.1502-21(b)(3)(i), which waives only the portion of the consolidated NOL that relates to the acquired member for all years in which it could be carried back to its former group. The split-waiver election was common in the pre-TCJA era since the carryback period was relatively short (two years), but it was only valid if made on the acquiring group’s originally filed tax return for the year of acquisition.
With the enactment of the TCJA, the rules under Section 172 were amended, effectively repealing the ability to carry back any NOLs generated in 2018 and thereafter, while also extending the carryforward period indefinitely. M&A transactions that were consummated in 2018, 2019, and 2020 may not have included language in the purchase agreement that specified which party would receive a tax benefit for an NOL carryback since it would not have been legally possible at the time of the deal. In addition, making a timely split-waiver election would not have been necessary for that same reason.
The CARES Act retroactively amended Section 172, allowing NOLs generated in 2018, 2019, and 2020 to be carried back for a period of five years. This creates a problem for many taxpayers who would have certainly already filed their 2018 (and possibly 2019) tax returns and would not have included the split-waiver election on timely filed tax returns. Absent new legislation, acquiring corporations were left with two not-so-appealing options: make the general waiver election and lose the opportunity to carry back any of their NOLs; or carry back their NOLs to get the cash refunds but lose NOLs attributable to its newly acquired members. Fortunately, temporary regulations were issued July 2, 2020, to address this issue. They provided two alternative split-waiver elections. Taxpayers can now make what is called an amended statute split-waiver election, which is an annual election that relinquishes the entire carryback period of any acquired members that would otherwise go into another taxpayer’s return year. In addition, taxpayers have the ability to make an extended split-waiver election that only applies to the extended carryback period, or the earliest three years of the five-year period. Both elections are irrevocable and require attaching a statement to a timely filed tax return pursuant to Section 1.1502-21T(b)(3)(ii)(C)(5).
Any future M&A purchase agreements should be carefully reviewed to ensure they address which party receives the NOL carryovers or carrybacks to address advantages that might not be achievable today but could be tomorrow.
James P. Swanick, CPA, is managing director in Global Tax Management Inc.’s Wayne office and a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org.
Michael J. Tighe, CPA, is associate director with Global Tax Management Inc. and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at email@example.com.