NOL carrybacks limited by excess distributions.

• Author: Wagner, Howard
• Position: Net operating losses

As 2012 drew to a close, many public and private companies paid significant dividends in advance of higher income tax rates and the 3.8% supplemental Medicare tax. If these companies incur a net operating loss (NOL) in 2013 or 2014, the corporate equity reduction transaction (CERT) rules could provide an unpleasant surprise and limit the carryback of NOLs. While practitioners typically think of the application of the CERT rules in cases of debt-financed distributions or stock acquisitions, the rules could apply even if the underlying transaction is not debt-financed.

The application of the CERT rules is a multistep process.

* Step 1: Determine if there is a CERT transaction involving an applicable corporation.

* Step 2: Determine if there is an NOL in a loss limitation year (LLY).

* Step 3: Determine if there is a corporate equity reduction interest loss (CERIL) in a loss limitation year.

* Step 4: Determine the portion of an NOL that can be carried back.

If there is a CERIL in a loss limitation year, a C corporation can carry back only the portion of the NOL for the loss limitation year in excess of the CERIL to a year prior to the year of the CERT transaction. Any NOL in excess of the CERIL not absorbed in a carryback year, and any portion of the NOL attributable to the CERIL can be used as a carryforward (Sec. 172(b)(1)(E)).

An applicable corporation is defined as: (1) a C corporation that acquires stock, or the stock of which is acquired in a major stock acquisition; (2) a C corporation making distributions with respect to, or redeeming, its stock in connection with an excess distribution; or (3) a C corporation that is a successor of a corporation making a major stock acquisition or an excess distribution (Sec. 172(b)(1)(E)(iii)). A major stock acquisition exists when a C corporation purchases more than 50% of the stock (by vote or value) of another corporation and an election under Sec. 338 is not made (Sec. 172(h)(3)(B)).

Many practitioners are aware of the application of the CERT rules to stock acquisitions but frequently overlook the application of the CERT rules to excess distributions. C corporations that made large distributions at the end of 2012 in anticipation of a higher top tax rate on dividends in 2013 should carefully consider the excess distribution rules. For purposes of the CERT rules, distributions include taxable and nontaxable distributions, as well as redemptions.

An excess distribution exists when the aggregate...