The Tax Cuts and Jobs Act (“TCJA”) of 2017 has major implications for corporate taxpayers, and one area of change is with regard to the use of net operating losses (NOLs). Under pre-tax reform law, NOLs could be carried back 2 years and forward 20 years. In addition, these NOLs are subject to a 90% limitation under the AMT rules, resulting in AMT tax at an effective rate of 2% (remaining 10% of tentative minimum taxable income not offset by NOL multiplied by 20% AMT rate). Effective with tax years ENDING after December 31, 2017, NOLs will no longer be allowed to be carried back, however they will have an indefinite carryover. Effective with NOLs incurred in years BEGINNING after December 31, 2017, there will be a limitation placed on their use, based on 80% of taxable income (in the year of use). This limitation replaces the AMT tax that would have been paid under the old rules when NOLs were used (AMT tax was repealed in the TCJA), however at a higher effective rate of 4.2% (20% of taxable income multiplied by a 21% corporate tax rate).
The result of this is that taxpayers will have two buckets of NOLs, those incurred before 2018 that have only a 20-year carryforward but can be used to offset 100% of taxable income, and those incurred after 2017 that have indefinite carryforward but can only offset 80% of taxable income. Fiscal year-end taxpayers will have a third bucket because of the inconsistency in effective dates of the carryover provisions and the limitation provisions, which allow for NOLs incurred in the tax year that straddles December 31, 2017 to be carried forward indefinitely and not be subject to the 80% limitation.
The changes to the NOL provisions could potentially have a significant impact on the financial statement treatment of these losses, given that they will not expire. Considerations would include whether a valuation allowance against the NOLs will be affected by the new rules, or whether these indefinite carryover losses can be used to offset indefinite-lived deferred tax liabilities (“naked credits”). From a valuation perspective, the reduction in the corporate tax rate has decreased significantly the future value of the NOLs. However, pre-2018 NOLs may retain some of that lost value, being that there will be no AMT tax or limitation placed on their future use.
With regard to Section 382, which limits the use of NOLs or other tax attributes when an ownership change has occurred and has historically only been a consideration of loss companies, profitable taxpayers may find that they could be subject to the 382 rules. Under the TCJA, interest expense limited by the new rules and carried over to future years is treated as an attribute subject to limitation under the 382 provisions. Therefore, taxpayers subject to this limitation need to consider whether they have had an ownership change that could affect their ability to deduct the interest carryover in the future.
In conclusion, there are many direct and indirect effects of the changes in the NOL provisions, both on cash tax liability and financial statement presentation. When possible, careful planning around the timing of deductions and recognition of income is recommended to make the most efficient use of NOLs and other carryovers considering the various pros and cons of these new rules.