Consolidated groups that acquire new members that were members of another consolidated group can elect to waive all or part of the pre-acquisition portion of an extended consolidated net operating loss (CNOL) carryback period under Section 172 for some loss attributable to the acquired members under final Treasury regulations (TD 9977) released on July 10.
The final regulations adopt without substantive change rules originally set out in temporary regulations issued in July 2020, implementing two alternative “split-waiver elections.”
The finalization of the regulations is largely administrative in nature, formalizing the response to certain CNOL carryback issues raised by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. For those entities with no ability to carryback under the Tax Cuts and Jobs Act (TCJA), the finalization of these election rules may currently be of limited significance. However, if and when there are future amendments to carryback periods, these final election rules could be more broadly applicable to affected consolidated groups.
For those consolidated groups that have or will acquire certain farming losses and losses incurred by non-life insurance companies, the potential to carryback to a selling group return still exists. Legal documents effectuating those transactions should be reviewed. If there is no provision specifically addressing NOL carrybacks and related elections, the acquiring consolidated group may wish to make an election under the final regulations for the purpose of waiving any carryback to a selling group return.
Background on Split-Waiver Elections
Net operating loss carrybacks were eliminated under the TCJA, except with respect to certain farming losses and losses incurred by non-life insurance companies. However, under the CARES Act, carrybacks for taxable years beginning in 2018 through 2020 became eligible for a five-year carryback, and fiscal year NOLs generated in taxable years beginning in 2017 and ending in 2018 became eligible for a two-year carryback. Unlike legislation passed during the financial crisis in the late 2000s, under the CARES Act, the NOL must be carried back for the full eligible period to the extent income exists, meaning taxpayers cannot elect for a shorter or modified carryback period, although there is some flexibility for carrying back to years with Section 965 income. This course of reversal on carrybacks resulted in a period in which parties to a transaction may not have considered the treatment of the target or target group’s NOL carrybacks following the acquisition (because carrybacks were prohibited at the time of the transaction). Once carryback periods were reinstituted by the CARES Act, the issue became relevant again.
A split-waiver election can be made pursuant to Treas. Reg. Section 1.1502-21(b)(3)(ii)(B) to waive a portion of the CNOL carryback period associated with a consolidated return group member that was previously a member of another group within the carryback period. The election is irrevocable and has to be made with the consolidated return reflecting the acquisition of the target or target group members. Prior to the release of the 2020 temporary regulations, the only alternative mechanism to elect to forgo a carryback of a CNOL was the annual election to forgo the entire group’s carryback pursuant to Treas. Reg. Section 1.1502-21(b)(3)(i). Therefore, if the group failed to make a split-waiver election in the year of a stock acquisition, the group would be required to carry back the target’s allocable portion of any CNOL to pre-acquisition periods unless the entire group elected to forgo its entire carryback. This could result in a portion of the tax benefit from the CNOL carryback of an acquiring group going to the consolidated group from which the target was acquired if the acquiring group was not willing to forgo its entire carryback.
The final regulations, like the 2020 temporary regulations, implement two alternative split-waiver elections aimed at providing additional flexibility: the amended statute split-waiver election and the extended split-waiver election. Importantly, these elections are available even where the election under Treas. Reg. Section 1.1502-21(b)(3)(ii)(B) was not timely made for the taxable year of acquisition.
Using the amended statute split-waiver election, an acquiring consolidated group can make an election with respect to a CNOL for the consolidated return year in which an acquired member was included and to which amended carryback rules apply. By making the election, the acquiring group relinquishes the carryback of the acquired member’s allocable portion of the CNOL to periods in which it was a member of another group. The election is made annually and eliminates the carryback for the extended five-year carryback period, as well as the default carryback period under Section 172.
As an example, suppose calendar year P Group acquires the stock of T from S during 2018. Prior to the acquisition, T was included in the S Group consolidated return. Following the acquisition of T, the P Group incurred CNOLs that were allocable in part to T; the amended statute split-waiver election would allow the P Group to waive any carryback of that portion of the CNOL to periods in which T was a member of the S Group. The P Group has the opportunity to make this election annually even though under preexisting regulations P would have had to make the election on the return reflecting the acquisition of T. In addition, the P Group has no responsibility to make the same election in the following year notwithstanding an election being made in the prior year. Whatever CNOL carryback is waived under the election is simply carried forward to the succeeding year.
Alternatively, the extended split-waiver election is largely the same as the amended statute split-waiver election, except that it only applies to forgo a carryback to the extended carryback period, meaning the default carryback period still applies.
For NOLs generated during 2019 and 2020, this election may seem irrelevant as the default carryback period is now zero following the TCJA. However, as Section 172 retained two-year carrybacks for certain farming and nonlife insurance companies, the extended split waiver election would waive the extended five-year carryback but not the default two-year carryback for eligible target entities. Furthermore, while the regulations are responsive to the carryback amendments from the CARES Act, these elections may be more broadly useful to the extent there are additional amendments to the carryback in the future.
Consistent with the temporary regulations, the final regulations apply to CNOLs generated in taxable years ending after July 2, 2020, but taxpayers may apply them retroactively to CNOLs generated for taxable years beginning after December 31, 2017.
The final regulations only address consolidated net operating losses. No similar election is available if a corporation is currently filing a standalone return and that corporation was formerly a member of a consolidated group. Modifying the example above, suppose Partnership A acquires the stock of T from consolidated group S on January 1, 2018, and T files a standalone C corporation return with positive taxable income in 2018. In 2019 T generates an NOL. T must either carry back the NOL the full five years allowed under the CARES Act, which would potentially result in part or all the carryback being absorbed by the S group or must elect to forgo the carryback entirely. No opportunity exists to carry back the 2019 loss only to 2018 since T is a standalone company.