CERTs and NOL limits.

• Author: Ochsenschlager, Thomas P.
• Position: Corporate equity reduction transactions, net operating loss

With the recent decline in the economy, some corporations will inevitably incur net operating losses (NOLs). The Job Creation and Worker Assistance Act of 2002 amended Sec. 172(b)(1)(H) to allow taxpayers a five-year carryback for losses incurred in tax years ending in 2001 and 2002, instead of the standard two-year carryback period. A flurry of refund claims is sure to follow. Many of these claims will be ultimately reviewed by the Joint Committee on Taxation (JCT).

However, an obscure rule may limit NOL carryback potential for some corporations that have financed either a recent acquisition of stock of another corporation or a capital distribution. Sec. 172(b)(1)(E) and (h), enacted by the Revenue Reconciliation Act of 1989 (RRA), contain hales on corporate equity reduction transactions (CERTs) and are unrelated to the Sec. 382 NOL limits. Taxpayers should consider these provisions, especially if quick refund claims are being filed. IRS sources have indicated that the JCT has alerted examiners to consider the CERT issue.

Background

The RRA Committee reports state that corporations' ability to carry back NOLs created by certain debt-financed transactions is contrary to the purpose of Sec. 172. Specifically, the rule's purpose is to allow corporations to smooth out the swings in taxable income that can result from business-cycle fluctuations and unexpected financial reverses. The Committee believed that when a corporation is involved in certain debt-financed transactions, the corporation's underlying nature is substantially altered. In addition, the interest expense in such transactions does not have a sufficient nexus with prior-period operations to justify a carryback of NOLs attributable to such expense. Accordingly, the Committee determined that it is inappropriate to permit a corporation to carry back an NOL generated by such transaction to a year before the year in which such transaction occurred; thus, only a carryover is permitted.

What Is a CERT?

A CERT is a major stock acquisition or an excess distribution. A major stock acquisition is defined by Sec. 172(h)(3)(B)(i) as the acquisition by a corporation (pursuant to a plan) of at least 50% (by vote or value) of the stock of another. "Qualified stock purchases" for which a Sec. 338 election is in effect are excepted under Sec. 172(h)(3)(B)(ii). Sec. 172(h)(3)CD) provides that all of a corporation's plans (or group of persons acting in concert with such corporation) as to another...