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Oct 19, 2020

IRS and Treasury Issue Final Regulations Regarding Use of Consolidated Net Operating Losses

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IRS AND TREASURY ISSUE FINAL REGULATIONS REGARDING USE OF CONSOLIDATED NET OPERATING LOSSES

On October 13, 2020, the U.S. Department of Treasury (“Treasury”) and the Internal Revenue Service (the IRS) released final regulations (T.D. 9927) (the “Regulations”) under sections 1502 and 1503 of the Internal Revenue Code of 1986, as amended (the “Code”),[1] regarding the absorption of consolidated net operating losses (CNOLs) carryovers applicable to consolidated groups that include one or more nonlife insurance company members and one or more life insurance and/or non-insurance company members. The Regulations also include certain rules with respect to the impact of the legislative changes to section 172 on the losses of members of a consolidated group that are subject to the separate return limitation year (SRLY) rules. The Regulations make only minor changes to regulations that were proposed on July 8, 2020 (the “Proposed Regulations”).

The Regulations do not finalize any part of the Temporary Regulations (T.D. 9900) issued on the same day as the Proposed Regulations that permit consolidated groups that acquire new members that were members of another consolidated group to elect to waive all or part of the pre-acquisition portion of an extended carryback period under section 172 for certain losses attributable to the acquired members.[2] However, the preamble to the Regulations states that such Temporary Regulations would be finalized in a later release.

Background

Prior to the Tax Cuts and Jobs Act (the TCJA),[3] corporations could carryback net operating losses (NOLs) to the two preceding taxable years in order to obtain a refund for the overpayment of taxes in such years and carryforward their NOLs for 20 years to offset taxable income, if any, in future taxable years. The TCJA amended section 172 to generally prohibit the carryback of NOLs arising in taxable years beginning after December 31, 2017 (with such NOLs being permitted to be carried forward indefinitely). Further, the TCJA limited a corporation’s ability to use NOL carryforwards generated in taxable years beginning after December 31, 2017 by only permitting such NOLs to offset 80 percent of the corporation’s taxable income in a given year (as reduced by pre-2018 NOL carryforwards) (the “80 percent limitation”).

However, the changes made to section 172 by the TCJA generally do not apply to nonlife insurance companies. Accordingly, NOLs generated by a nonlife insurance company (regardless of when they were generated) may be carried back two years and carried forward 20 years and are exempted from the 80 percent limitation. Thus, nonlife insurance companies are subject to special rules under section 172 both with respect to the amount of taxable income that may be offset by NOL deductions and with respect to the taxable years to which NOLs may be carried.

The Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”)[4] modified the 80 percent limitation to permit post-2017 NOLs to offset 100 percent of a corporation’s taxable income arising in its 2018 through 2020 taxable years (though NOLs generated in such corporation’s 2018 through 2020 taxable years will still be subject to the 80 percent limitation if such NOLs are used to offset taxable income arising in taxable years beginning after 2020). The Regulations provide guidance on the application of 80 percent limitation for tax years beginning after 2020 (i.e., tax years for which the 80 percent limitation is reinstated) to consolidated groups that include one or more nonlife insurance companies and one or more other members.

Computation of the 80 Percent Limitation

To implement the special rules under section 172 for nonlife insurance companies for taxable years beginning after 2020, the Regulations generally provide that the application of the 80 percent limitation within a consolidated group with respect to post-2017 NOLs depends on the status of the group member that generated the income being offset (rather than the status of the entity whose CNOL is being absorbed).

With respect to a consolidated group that includes one or more nonlife insurance company members and one or more other members, the Regulations establish a two-factor computation to determine the amount of a CNOL that may be absorbed by one or more members of the consolidated group (the “Post-2017 CNOL Limit”) for a consolidated return year beginning after 2020.

Assuming that the consolidated group does not have any pre-2018 CNOL carryforwards and both the nonlife insurance company members and other members of the consolidated group have positive consolidated taxable income (CTI), the Post-2017 CNOL Limit is equal to the lesser of:

  • The aggregate amount of post-2017 NOLs carried to that year, or
  • The sum of the amounts in the “nonlife income pool” and the “residual income pool.”

The “nonlife income pool” consists of 100 percent of the income from the nonlife insurance company members. The “residual income pool” consists of 80 percent of the excess of:

  • The CTI of the consolidated group for such taxable year, determined without regard to any income, gain, deduction or loss of members that are nonlife insurance companies and without regard to any deductions under sections 172, 199A and 250, over
  • The aggregate amount of pre-2018 NOLs carried to that year that are allocated to that income pool by applying the 80 percent limitation.

If a consolidated group has a pre-2018 CNOL carryforward, that amount is allocated pro rata between the income pools in proportion to their current-year income and reduces the available CTI in each pool proportionately.

CNOLs that do not exceed the Post-2017 CNOL Limit are then applied against the entire CTI of the consolidated group.

The Regulations specifically address the calculations made when the CTI of one of the pools is negative, but the other is positive, and the consolidated group has positive CTI. In that situation, the Regulations provide:

  • If the nonlife income pool is positive and the residual income pool is negative, the CNOL deduction limit is equal to 100 percent of the CTI of the consolidated group.
  • If the nonlife income pool is negative and the residual income pool is positive, the CNOL deduction limit is equal to 80 percent of the CTI of the consolidated group. 

Mixed Life Insurance and Nonlife Insurance Groups

Existing Treasury regulations provide rules for the allocation of CNOLs between life insurance and nonlife insurance groups that are part of the same consolidated group. The Regulations update these existing regulations to reflect statutory and regulatory changes that occurred since the existing regulations were published. However, Treasury and the IRS explicitly declined to provide substantive updates to such regulations, stating that such changes were beyond the scope of the Regulations.

Separate Return Year Limitation

Existing Treasury regulations provide that, unless the acquiring consolidated group makes a waiver election, if any portion of a CNOL attributable to an acquired member in a post-acquisition taxable year may be carried back under section 172 to a separate return year of the acquired member (or a taxable year in which the acquired member was a member of another consolidated group), such portion of the CNOL must be so carried subject to the separate return limitation year (SRLY) rules. For these purposes, a separate return year includes a taxable year in which the acquired member was a member of its prior consolidated group. Members of a consolidated group that are subject to the SRLY limitation (“SRLY members”) must maintain a cumulative SRLY register to account for their aggregate contributions to the consolidated group’s CTI.

The Regulations provide rules for taking the 80 percent limitation into account when calculating the amount of a member’s SRLY register. Specifically, when a SRLY member has a SRLY-limited loss that is absorbed by its acquiring consolidated group that is also subject to the 80 percent limitation, the member’s SRLY register is reduced by the full amount of income needed to support a deduction of that loss. For example, if a SRLY member generates an $80 loss that is absorbed by its acquiring group, its register is reduced by $100.

Additionally, the Regulations provide that the above rules for implementing the 80 percent limitation do not apply to SRLY calculations made under the dual consolidated loss regulations.

Applicability Dates

Generally, the Regulations will apply to taxable years beginning after December 31, 2020. However, a taxpayer may choose to apply Treas. Reg. § 1.1502-1(k) (updated definition of a nonlife insurance company) and Treas. Reg. § 1.1502-47 (allocation in a group with life and nonlife insurance companies) to taxable years beginning on or before December 31, 2020. If a taxpayer chooses to apply Treas. Reg. § 1.1502-47, it must apply the rules in their entirety and consistently with other Code provisions applicable to the same year.

Footnotes

[1]  Unless otherwise indicated, all “section” references contained herein are to sections of the Code.
[2]  See prior coverage.
[3]  Pub. L. No. 115-97
[4]  Pub. L. No. 116-136

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