Question

"Consolidated Net Operating Losses and Consolidated Tax Returns"

• Imagine that a client is pursuing the acquisition of Corporation A that has a substantial net operating loss. Corporation B is a member of the controlled group and is currently included in the consolidated tax return that also has a net operating loss. Analyze the potential advantages and disadvantages of Corporation B’s acquisition of Corporation A and Corporation A’s subsequent inclusion in Corporation B’s consolidated tax return. Suggest the key tax issues the client should consider in determining the deductibility of the net operating losses. Evaluate the impact of the Tax Cuts and Jobs Act (TCJA) on the net operating losses.

Answer 1

Some advantages of the acquisition of Corporation A are no tax on intercompany distributions and they can set off or carry forward their loss in the years ahead. Also, unused tax credit of Corporation A can be used. The key tax issue the client should consider in determining the deductibility of the NOL is that there is limits for the income against which the NOLs has to be deducted, as well as limits for the tax liability for which tax attributes need to be applied or adjusted.

NOLs occur when you have more tax deductions than taxable income. NOLs usually happen when you own or co-own a business that loses money. They can occur in businesses of all sizes, from small sole proprietorships to big corporations. If you're a sole proprietor, your business losses are always deducted on your personal tax return. If you're the owner or co-owner of a business organized as a partnership, limited liability company (LLCs), or S corporation, any losses pass through the business to you and any other owners who may deduct their share on their individual returns. If you're the shareholder in a C corporation, any losses are deducted by the corporation, not by the shareholders.

It is possible for an individual who is not a business owner to have an NOL. This can occur when a person has large casualty losses—for example, a taxpayer’s home is destroyed in a federally declared disaster and he or she had no or inadequate insurance, resulting in a large deductible casualty loss that exceeds the taxpayer's income. In such cases, the casualty loss is treated the same as a business loss. Follow the rules for non-corporate taxpayers, such as sole proprietorships.

In the past, business owners could “carry a loss back”—that is, they could apply an NOL to past tax years by filing an application for refund or amended return. This enabled them to get a refund for all or part of the taxes they paid in past years. NOLs could generally be carried back two years. However, the TCJA eliminated carrybacks for NOLs. Starting in 2018 and continuing through 2025, an NOL may only be deducted against the current and future taxes. However, a two-year carryback continues to apply for certain losses incurred by farming businesses. Also, the old rules continue to apply to NOLs incurred before 2018.

Moreover, the TCJA permits taxpayers to deduct NOLs only up to 80% of taxable income for the year (not counting the NOL deduction). Any unused NOL amounts may be carried forward any number of future years. This means you deduct it from your future year’s taxes until you use it up. (Under prior law, which continues to apply to pre-2018 NOLs, NOLs could be carried forward no more than 20 years.)

The Tax Cuts and Jobs Act (TCJA) brings significant changes to the tax code and offers new challenges for tax advisors. Those same challenges offer a number of benefits for taxpayers, especially business filers. However, it is best to temper a client’s expectations, as not every change introduced by the TCJA will benefit them.

Net Operating Losses (NOLs) are one of the changes that many may be disappointed to learn lessens a powerful benefit from the prior tax code. Let’s take a closer look at the changes that will have the greatest impact on tax planning for any client with a current or anticipated net operating loss for the upcoming tax year.