WorldCom's NOL plans extinguished?

• Position: Net operating losses

BY THE AICPA TAX DIVISION'S CORPORATIONS & SHAREHOLDERS TAXATION TECHNICAL RESOURCE PANEL'S CONSOLIDATED TAX ISSUES TASK FORCE

A recent article (1) claimed WorldCom Inc. is "exploiting" the Code to preserve its net operating losses (NOLs) as it emerges from bankruptcy. In an unstated reference to Sec. 382, the article notes that WorldCom is changing its bylaws to preclude, for two years, any party flora acquiring more than a 4.75% stock interest.

WorldCom appears to think it will have a post-bankruptcy Sec. 382 problem, even though its bankruptcy filing is the largest in history. There is a quid pro quo for the debt relief obtained. In exchange for excluding the debt relief from income under Sec. 108(a), a debtor must reduce its tax attributes under Sec. 108(b)--primarily NOLs--to get a "fresh start" (not a "head start") over solvent taxpayers that had to use their tax attributes to offset debt discharge income not excluded under Sec. 108(a).

Why does WorldCom expect to emerge from bankruptcy with significant NOLs? As a consolidated return filer, the WorldCom group apparently takes the position that Sec. 108 attribute reduction can be done on a separate-company (i.e., member-by-member) basis. In response, Sen. Rick Santorum (RPA) introduced S. 1331. (2) In the accompanying floor statement, (3) he claimed that WorldCom will obtain $35 billion in debt relief from its bankruptcy filing, but will not reduce its NOLs by a comparable amount. According to Son. Santorum, Worldcom's separate-company argument would leave its principal subsidiary, MCI, with its $10-$15 billion NOL largely intact, thus permitting MCI to shelter that much future income.

This prospect is understandably alarming to MCI's competitors. S. 1331 would require attribute reduction on a consolidated basis. As support for the bill, Sen. Santorum cites United Dominion Industries, Inc., (4) in which the Supreme Court, in the absence of specific rules, applied a consolidated approach to the determination of the 10-year carryback for product liability losses provided by former Sec. 172(b)(1)(I).The difference between the two approaches is illustrated below.

Example 1: P Corp. is the common parent of a group filing a consolidated return with its two wholly owned subsidiaries, S1 and S2. At the end of 2002, the P group had a $50 million consolidated net operating loss (CNOL); $10 million was attributable to $1 and $40 million to S2. However, S2's fortunes continued to decline during...