The Tax Cuts and Jobs Act (TCJA) made some major changes to the tax treatment of net operating losses (NOLs). These changes will affect tax returns and financial statements for years to come, requiring taxpayers to track multiple categories of NOLs and adding complexity in the event of an ownership change.
Pre-TCJA rules generally let a taxpayer carry back an NOL two years or carry it forward 20 years. In addition, these NOL carryovers and carrybacks were available to fully offset taxable income, unless the taxpayer was subject to alternative minimum tax or other restrictions, such as Section 382 limitations (see below). The TCJA eliminated NOL carrybacks, but it does allow indefinite carryforwards. The TCJA also limits the NOL utilization to 80 percent of taxable income.
These different treatments will result in two different categories of NOLs that a taxpayer must track: NOLs carried forward from before the TCJA must be tracked for a 20-year tax period, while those incurred after the TCJA should be accounted for separately since there is no expiration.
Beyond income tax returns, this dual treatment must also be reflected in the tax provision of the financial statements. The decrease in future tax rates has decreased the future value of NOLs that have been on the books since before the TCJA. On the other hand, the indefinite carryforward of later NOLs might make them eligible to offset deferred tax liabilities with indefinite lives.
Clarification Needed on Dates
In general, the TCJA provisions apply for tax years beginning after December 31, 2017. However, a possible drafting oversight has led to inconsistency between the date that applies to the carryforward provision (effective for tax years ending after December 31, 2017) and the date for the 80 percent limitation provision (effective with tax years beginning after December 31, 2017). Therefore, in a tax year that straddles December 31, fiscal-year taxpayers might have incurred NOLs that can be carried forward indefinitely and/or are not subject to the 80 percent limitation. However, this point will need to be clarified through a technical correction.
Time for a Section 382 Study?
Taxpayers should also understand how the TCJA might affect the availability of NOLs and other tax attribute carryforwards in the event of an ownership change. Section 382 limits the amount of income that can be offset by NOLs and other tax attributes once the corporation has undergone an ownership change.
Another new provision in the TCJA — the limitation on deductibility of business interest — can also raise the need for a Section 382 study. Previously, business interest expense was generally deductible in the year in which that interest was paid or accrued. The TCJA now limits the deductibility of net business interest expense, but also allows it to be carried forward indefinitely. Given that interest expense is another tax attribute subject to limitation under Section 382, even a company with no NOLs might consider having a Section 382 study performed if it is considering any material transaction or financing activity.
As always, the individual facts and circumstances of your business need to be evaluated in light of the new rules to determine their effect. Consult your tax advisor to devise a plan for complying with the new rules while maintaining the greatest benefit from your business losses and other expenses.
January 21, 2019
