Effective NOL Planning in Light of Tax Reform: Can your company unlock the value of net operating loss carryforwards to reduce future taxable income?

• Author: Reinstein, Todd
• Position: FEDERAL TAX

Under current tax rules, a corporation can generally carry back a net operating loss (NOL) to the two preceding taxable years and carry it forward up to the twenty taxable years following the loss to offset 100 percent of federal taxable income and ninety percent of the alternative taxable income. Section 13302 of H.R. 1 changes the NOL rules. (1) Section 13302 eliminates the ability to carry back NOLs generated in taxable years beginning after December 31, 2017, except for certain farming NOLs.

The NOL carryforward period for new NOLs would also change from the current twenty succeeding taxable years to an indefinite period. With the elimination of the alternative minimum tax, NOLs for taxable years beginning after December 31, 2017, can offset 100 percent of federal taxable income with no reduction for the alternative minimum tax. (2) Since several other parts of the legislation limit or eliminate traditional deductions for corporate income taxpayers, such as interest expense, Section 199 deductions, and entertainment expenses, corporate taxpayers will likely look to NOLs to potentially offset future taxable income. Corporate taxpayers may also look to NOLs to offest income arising from the deemed transition tax under the new Section 965 for tax year 2017.

Taxpayers planning to use NOLs in either the current tax regime or new regime should be aware of the rules that could limit or eliminate the ability to use NOLs. The primary provision that governs the use of NOLs is Section 382. (3) Whether you are a loss corporation calculating your own limitation or your company is acquiring a corporation with NOLs or built-in losses, there are a number of practical tips for applying the rules. However, an introduction to the rules is needed to understand those practical tips. Section 382 generally requires a corporation to limit the amount of its income in future years that can be offset by historic NOLs once the corporation has undergone an "ownership change."

A loss corporation as defined in Section 382 is a corporation entitled to use an NOL carryforward (among other tax attributes) or having NOLs for the taxable year in which the ownership change occurs. In addition, a loss corporation includes any corporation with a net unrealized built-in loss. Taxpayers often miss this last rule, particularly when they look to apply these rules only when there is an NOL carryover. The consequences as discussed below could be dire, because post-change losses could be subject to the Section 382 limitation, thereby increasing tax liability in post-change years.

Section 382 requires that a loss corporation determine whether an ownership change occurred as of a certain "testing date." Generally, a testing date is any date in which there is any owner shift, issuance of stock, or issuance or transfer of an option with respect to the stock of the loss corporation. Pursuant to Treas. Reg. Section 1.382-2(a) (4)(i), a loss corporation is required to determine whether an ownership change has occurred immediately after any owner shift, stock issuance, or transfer. Generally, the "testing period" for any testing date is the three-year period ending on the testing date. Once an ownership change occurs, the three-year testing period is reset and a new testing period begins.

Identifying Five-Percent Shareholders

The first step to applying Section 382 rules is to determine which shareholders to track and to determine ownership percentages on each testing date for these shareholders or groups of shareholders known as "public groups." Section 382 and the Treasury Regulations promulgated under it require that a loss corporation calculate increases in the percentage of stock ownership of its five-percent shareholders to determine whether an ownership change occurred on a testing date. A loss corporation is thus required to identify and determine the percentage ownership of each five-percent shareholder on each testing date.

The ownership of each five-percent shareholder on that date is compared with such shareholder's lowest percentage of ownership on any previous testing date during the testing period (which is generally the shorter of (i) the three-year period ending on the current testing date or (ii) the period of time since the last ownership change and the current testing date). An ownership change will occur if one or more five-percent shareholders increase their ownership, in the aggregate, by more than fifty percentage points...