Net Operating Loss Planning After Tax Reform:...

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Net Operating Loss Planning After Tax

Reform: Planning Techniques and ChallengesImpact to US Taxpayers, Timing Issues and Other Considerations

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, JANUARY 9, 2019

Presenting a live 90-minute webinar with interactive Q&A

Patrick M. Cox, Partner, Baker McKenzie, New York

Nick Gruidl, Partner, Washington National Tax, RSM US, Washington, D.C.

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Strafford NOL Presentation

Patrick M. Cox

[email protected]

January 9, 2019

© 2019 Baker & McKenzie LLP

Net Operating Losses Before and After Tax Reform

6

• Net operating losses, or NOLs, are a feature of the Internal Revenue Code (the “Code”), that allow taxpayers to benefit from excess deductions, by using those deductions in other tax periods, when the taxpayer has income against which the deductions can be used.

• In this way NOLs benefit companies with fluctuating income and start-up companies.

• For example, absent NOLs, and assuming a 35% tax rate, Company XYZ with $200 Year 1 income and $100 Year 1 deductions, and $100 Year 2 income and $200 Year 2 losses, would pay $35 in taxes in Year 1 and no taxes in Year 2 for an overall liability of $35. Another taxpayer, Company ABC, with the same two year period of income ($300) and losses ($300), but having $100 of Year 2 losses being incurred in Year 1, instead of Year 2, would owe zero taxes. The NOL carryback was intended to tax Company XYZ and Company ABC similarly.

Background



7

• Prior to the Tax Cuts and Jobs Act (the “TCJA”), NOLs could be carried back two years and forward 20 years. The TCJA amended Section 172 to provide that NOLs arising after 2017 can no longer be carried back, but may be carried forward indefinitely.

• Carryback is still allowed for farming losses and non-life insurance companies. The 20 year carryforward still applies to non-life insurance companies.

• Prior to TCJA specified liability losses could be carried back 10 years. This carryback provision was also eliminated by the TCJA.

• In the example on the prior slide, a prior policy objective of NOLs is no longer served, as Company XYZ will have to carry forward its $100 NOL (no more carryback) and hope that it can use it to offset future income. At a minimum, under time value of money concepts Company XYZ is worse off as compared to Company ABC.

• As a result, the TCJA favors start-ups as compared to companies with fluctuating income, since start-ups rarely have taxable income in early years and only need to carry NOLs forward, which is allowed (indefinitely) under the TCJA.

Modification of Carryback and Carryover Rules



8

• The TCJA further amended Section 172 to provide that NOLs arising after 2017 can only offset 80% of taxable income.

• 80% limit does not apply for non-life insurance companies.

• Prior to TCJA it was necessary to calculate the alternative minimum tax (“AMT”) NOL (operating as a 90% limit on use). The TCJA abolished the corporate minimum tax and so this is no longer necessary.

• While the 20-year carryforward still applies to pre-TCJA NOLs, the repeal of the corporate AMT, and the fact that such NOLs can offset 100% of corporate taxable income, means that these NOLs are more valuable for certain corporations after TCJA.

Application of 80% Limitation



9

• The reduction in the corporate tax rate to 21% and the 80% cap on NOLs immediately reduced the value of NOLs as a tax attribute for distressed companies and their investors.

• Moreover, the TCJA introduces new tax regimes that are calculated based by using some or all of NOL carryovers to calculate tax.

• The base erosion anti-abuse tax (“BEAT”) haircuts NOLs based on a percentage, thereby partially disallowing NOLs.

• The global intangible low-tax income (“GILTI”) and foreign derived intangible income (“FDII”) allow a deduction (under Section 250) and the amount of the deduction is calculated based on taxable income reduced by NOLs, thereby reducing the deduction (benefit) and again arguably reducing the value of NOLs.

• BEAT, GILTI and FDII are discussed in more detail below.

New Tax Reality for Tax Attributes



10

• The reduction in the corporate tax rate to 21% and the 80% cap on NOLs has a direct impact on “tax receivable agreements” (“TRAs”).

• Many companies with significant tax attributes entered into TRAs over the past decade or so as part of M&A transactions in an effort to monetize these tax attributes. Advisors claimed that tax attributes were not properly reflected in the share value of companies doing initial public offerings (or otherwise).

• A TRA, like its cousin, the tax sharing agreement (“TSA”), is an agreement that compensates one party for the use of another party’s tax attributes. TRAs have been used by private equity firms when selling companies in structured deals that are designed to preserve and maximize the value of tax attributes such as NOLs.




11

• The reduction in the corporate tax rate to 21% and the 80% cap on NOLs has a direct impact on “tax receivable agreements” (“TRAs”).

• In the typical TRA, following the merger or acquisition, the restructured company is obligated to pay cash to the private equity firm equal to a percentage (usually 85%) of the tax attributes utilized.

• One bright spot for such companies under the TCJA is that their obligation under these TRAs (or TSAs) is reduced because of the reduction in the corporate tax rate from 35% to 21% and the 80% cap on the post-2017 NOLs.

• From an investor’s perspective such obligor-companies should be more attractive after TCJA. On the flip-side, the value of many, if not all, of these TRAs to private equity firms took a hit under the TCJA.




12

• The TCJA revised Section 163(j), the Code provision limiting interest deductions. These revisions have implications to NOLs generally and should also be considered when analyzing the tax implications to distressed companies and their investors.

• “Adjusted Taxable Income” or “ATI” used to measure the limit under Section 163(j) (30% of ATI + business interest income and + floor plan financing amounts = the limit) is calculated without regard to NOLs.

• The amount of carryover business interest expense (disallowed under Section 163(j)) can carryover in a Section 381 transaction and then convert into an NOL, subject to limitation under Section 382.

• Although it is not entirely clear from the statute, it is likely that any amount of interest that is limited under Section 163(j) and carried forward would be considered a “pre-change loss” for purposes of Section 382.

• Distressed companies tend to be highly leveraged and the TCJA’s changes to Section 163(j) further increase the likelihood that these companies will not be able to utilize interest deductions and consequently may increase their cost of capital.

Section 163(j)



14

• For NOLs arising after 2017, it is now necessary to calculate the base erosion percentage associated with the year the NOL originated, as that percentage will apply for purposes of utilizing the NOL to offset the Section 59A base erosion anti-abuse tax (“BEAT”).

• The preamble to the TCJA and the statutory language of Section 59A were unclear as to whether the base erosion percentage (or “BE%”) for NOLs (used to calculate modified taxable income subject to the 10% BEAT tax) was based on the year the NOLs originate or the year of their use.

• This uncertainty led to potentially bizarre circumstances where a US taxpayer with NOLs would be better off not making deductible interest payment (at all) to related foreign parties.

BEAT



15

• Facts

• NOLs = $200 Million

• Income = $100.00

• Interest Deduction = $30.00

BEAT - Example

Foreign

Parent

Borrower

Loan

US

OpCo



16

• NOLs = $200 Million

• Income = $100.00

• Interest Deduction = $30.00

• $30 of interest is deductible (163(j) cap is $30).

• $56 of NOLs is available (80% of $70).

• Regular tax is $2.94 (21% of $14).

BEAT - Example

Foreign

Parent

Borrower

Loan

US

OpCo



17

• BEAT is $14 + $30 + (100% x $56 NOL) = $100 x 10% = $10 (because this is greater than $2.94, this is the amount owed by the taxpayer).

• This $10 BEAT assumes a base erosion percentage for the NOL of 100%, which is this company’s base erosion percentage in the year the NOL was utilized. However, what if the NOL originated in a year when the BE% was less than 100% or prior to BEAT altogether (2017 or earlier)?

BEAT - Example

Foreign

Parent

Borrower

Loan

US

OpCo



18

• The BEAT regulations clarify that the base erosion percentage for NOLs is based on the year the NOL originated (referred to in the regulations as the “vintage-year base erosion percentage”) (Prop. Reg. Section 1.59A-4(b)(2)(ii)) and the proposed regulations also make clear that the BE% for pre-2018 NOLs is zero (thus allowing full use of such NOLs to reduce modified taxable income).

• This fixes the bizarre result arising in the prior example, where there could be a complete disconnect between the base eroding payment and the origin of the NOLs. It further fixes the harsh result that could have applied if a taxpayer was trying to use pre-BEAT NOLs to reduce it modified taxable income under the BEAT.

• However, because of this “vintage” rule, it will be necessary for taxpayers to track the BE% for each period’s NOLs, which will be an administrative burden to bear for companies.

BEAT



19

• The GILTI operates as a global minimum tax. The FDII, generally, is an incentive for US taxpayers to develop and exploit intangibles in the US instead of offshore.

• The tax (GILTI) and deduction (FDII) are calculated using a formula that runs through Section 250. Specifically, Section 250 provides a deduction to the taxpayer that provides a 50% reduction to GILTI (resulting in an effective rate of 10.5% through 2025, and a rate of 13.125% thereafter, when the deduction reduces to 37.5%) and a separate deduction to certain income (FDII) that makes the effective rate on that income as low as 13.125%.

GILTI and FDII



20

• What is important to consider about GILTI, FDII and the Section 250 deduction, in relation to NOLs is how the Section 250 deduction is calculated.

• There is some uncertainty as to why NOLs work to reduce this Section 250 deduction in the manner provided in the statute. When a taxpayer’s non-GILTI and non-FDII is less than the taxpayer’s current losses or NOL carryovers to the tax year, then Section 250(a)(2) requires that the excess be used to offset GILTI and FDII eligible for the Section 250 deduction. In this manner the losses are used but in a manner that only provides for a fraction of the benefit from the losses (10.5% instead of 21%).

• It is not at all clear if this was the intended result for these rules.

• This approach hurts distressed companies with little or no taxable income.

• The New York State Bar Association has raised concern about this “carve-back” approach, as they put it, in both of their reports on the GILTI regulations (Reports ## 1394 and 1406).

GILTI and FDII



21

• Calculating the amount of a taxpayer’s NOL requires one to reduce allowable deductions by gross income (as modified by Section 172(d)). See Section 172(c).

• For purposes of calculating the amount of NOLs, “gross income” under Section 172(c) excludes amounts deductible under Section 199A (partnership passthrough deduction) and Section 250 (foreign-derived intangible income or “FDII”). This is clear from the statute which adds Sections 172(d)(8) and (d)(9).

• However, the statute is not clear as to whether, “taxable income” under Section 172(a)(2) (for purposes of setting the 80% cap) is calculated without regard to amounts deductible under Section 199A (partnership passthrough deduction) and Section 250 (foreign-derived intangible income or “FDII” and global intangible low-taxed income or “GILTI”).

• The Joint Committee on Taxation (“JCT”) issued a “Technical Explanation of The House Ways and Means Committee Chairman’s Discussion Draft of the “Tax Technical and Clerical Corrections Act” on January 2, 2019 (“JCT Draft Technical Corrections”). The JCT Draft Technical Corrections clarifies that the intent was to exclude these amounts when calculating “taxable income” which benefits the taxpayer.

Calculating NOLs



22

• Calculating the use of NOL carryovers where there are 80%-limited NOLs (post-2017) and unlimited NOLs was uncertain under TCJA.

• The JCT issued its “General Explanation of Public Law 115-97 (TCJA) in December 2018 (“JCT Bluebook”) to help clarify TCJA. The JCT Bluebook provides that a taxpayer is first to use its pre-2018 NOLs to offset income and then utilize the lesser of (a) its post-2017 NOLs or (b) 80% of its taxable income (after application of pre-2018 NOLs, but before application of post-2018 NOLs).

• Example (from JCT Bluebook, page 181): Taxpayer (“TP”) has $120 of pre-2018 NOL carryovers and $70 of post-2017 NOL carryovers to 2019. TP has $100 of taxable income in 2019 (before any NOL). TP can use $100 of $120 pre-2018 NOLs to offset all of TP’s 2019 taxable income, leaving $20 of pre-2018 NOL carryovers and $70 of post-2017 NOL carryovers to 2020. TP has $100 of taxable income in 2020. TP can use $20 of pre-2018 NOLs and $64 of post-2018 NOL carryovers (the lesser of (i) its post-2018 NOL carryovers ($70) and (ii) 80% of its 2020 taxable income after apply pre-2018 NOLs (80% x $80 = $64)).

Calculating NOLs - Ordering Rules



23

• The final version of the TCJA incorrectly used effective date language that made it unclear as to how fiscal year taxpayers should apply the new NOL limitations. Specifically, some of the TCJA’s NOL limitations apply to tax years beginning after December 31, 2017, while others take effect in tax years ending after December 31,2017.

• This inconsistency should not impact calendar year taxpayers, however, it requires correction for fiscal year taxpayers.

• Specifically, a taxpayer with a February 2018 year-end, could have lost the carryback rights for NOLs arising during its taxable year that began on February 2017, months before enactment of TCJA.

• Thankfully, the JCT Bluebook clarifies that the intent of the statute is to apply the NOL limitations relating to the indefinite carryover and denial of carryback to tax years beginning after December 31, 2017. However, the JCT Bluebook acknowledges that a technical correction may be necessary to reflect this intent.

Calculating NOLs – Timing Rules for Fiscal Year Taxpayers



24

• When calculating the Notice 2003-65 “boost” (as discussed further below), the TCJA’s new Section 168(k) 100% expensing rule is ignored (see Notice 2018-30).

Calculating NOLs – The “Boost”



25

• The TCJA added paragraph (l) to Section 461, the general rule for determining the year of a deduction under Subtitle A of the Code (income taxes).

• For tax years beginning after 2017 and before January 1, 2026, an “excess business loss” of a non-corporate taxpayer is not allowed for the year in which it arises, but such excess amount is treated as an NOL for purposes of calculating the NOL carryover to subsequent years.

• For partnerships and S corporations the “excess business loss” is determined at the partner or shareholder level.

Calculating NOLs – Taxpayers Other Than Corporations



26

• An “excess business loss” for a taxable year is the excess of aggregate deductions attributable to trades or businesses of the taxpayer (determined without consideration of Section 461(l)), over the sum of aggregate gross income or gain attributable to trades or businesses of the taxpayer plus a threshold amount ($250,000 in 2018; $500,000 for joint filers; indexed for inflation).

• For example, if husband and wife have $700,000 of deductions, $80,000 of gross income from trades or businesses, the “excess” would be $120,000.




27

• The JCT Bluebook acknowledges that several technical corrections are necessary with respect to Section 461(l):

• Clarifying that aggregate deductions are calculated without regard to Sections 172 and 199A.

• Clarifying that an excess business loss does not take into account gross income or gains or deductions attributable to a trade or business of performance of services as an employee (e.g., wage income).

• This is in direct conflict with statements from the IRS in IR-2018-254.

• The JCT Draft Technical Corrections is consistent with the JCT Bluebook position.




28

• Because certain benefits of the TCJA only apply to corporate owners, such as the Section 250 deduction applicable to the GILTI, many taxpayers considered using US corporate holding companies in lieu of LLCs or other passthrough entities.

• The danger here is that the accumulated earnings tax (Section 531) or personal holding tax (Section 541) could apply. Discussion of these “dormant” provisions is beyond the scope of this presentation but are raised here because NOLs are generally not allowed to offset taxes arising under these provisions.

Using Corporations After TCJA



29

• Whether states and localities adopt the TCJA, including the NOL provisions, will depend on the particular state or locality.

• States may diverge from federal tax law via state “decoupling” modifications.

• States may also be forced to diverge from federal tax law due to constitutional constraints.

• Taxpayers must separately track, monitor, and implement state modifications to federal provisions.

State and Local Tax Considerations



30

• There are generally three types of Federal conformity:

• Rolling conformity: the state conforms to the Internal Revenue Code as currently in effect. Conformity to new federal provisions does not require legislative action by the state.

• Static conformity: the state conforms to the Internal Revenue Code as of a particular date. Conformity to new federal provisions requires legislative action by the state.

• Selective conformity: the state conforms to particular provisions of the Internal Revenue Code on a rolling or static basis. Conformity to new federal provisions often requires legislative action by the state.


© 2019 Baker & McKenzie LLP 31

Source: Bloomberg BNA, IRC Conformity; Federation of Tax

Administrators 2016 State Tax Collection by Source





32

• Recent Guidance:

• The JCT Bluebook was issued in December 2018, but this did not clarify all the uncertainties surrounding the NOL rules and it is unclear when proposed regulations in the area of Section 172 will be forthcoming. Further, as noted above, the document admits in numerous places that technical corrections may be necessary and with a divided Congress it is unclear when such corrections will become law.

• The JCT Draft Technical Corrections. This document clarifies some of the issues, for example as discussed above with respect to Section 461(l), however, as noted immediately above, it is not at all clear whether a technical corrections bill will make it through the 116th

divided Congress and Senate, and thus when, as in this example, the proposed technical correction is in direct conflict with other guidance, taxpayers are especially hamstrung.

Questions Remain

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© 2018 RSM US LLP. All Rights Reserved. © 2018 RSM US LLP. All Rights Reserved.

Nick Gruidl

[email protected]

© 2018 RSM US LLP. All Rights Reserved. © 2018 RSM US LLP. All Rights Reserved.

SECTION 382:NUBIG/NUBIL & RBIG/RBILNotice 2003-65 and §965

© 2018 RSM US LLP. All Rights Reserved.

§382 Limitations After an Ownership

Change


Where to start:

• Value of stock acquired divided by % of corporation shares acquired− Somewhat more complicated with the existence of

numerous classes of shares that may not all have values easily determinable

• Increased by §1504 stock not treated as stock for purposes of determining an ownership change

• Note that GAAP purchase price is not a good starting point− Look to the flow of funds or sources and uses documents

§382 – Calculating the Limitation

38


Primary adjustments to value:

• In the money options (potentially an increase)

• Capital contributions and other issuances of stock

within the two year period preceding the ownership

change

− Cf. Notice 2008-78 which reverses this presumption

• Corporate contractions in conjunction with the

ownership change

− LBO is the most common example


39


In the money options:

• In general, the “in the money” portion of options increases the equity value

Corporate contractions:

• Redemptions and similar transactions

• Example:− P acquires LossCo via a reverse cash merger (See Rev Rul

90-95) for $100M

− P funds the acquisition with cash and debt incurred by the transitory subsidiary of $40M

− What equity value should you use for §382 purposes?


40


Carryover of unutilized limitation

• The annual limitation for a subsequent tax year is

increased by the cumulative amount of prior year

unutilized limitation

• Example:

• LossCo incurs an ownership change and has an

annual limitation of $100 1/1/18

• LossCo generates losses in ‘19 & ‘20

• What is the annual limitation for the 12/31/21 year?


41


• Oldest NOLs first – subject to the §382 limitation

• Example:

− LossCo generated NOLs in 2010 through 2016

• $500 each year ($3,500 total)

− LossCo incurred an ownership change 12/31/13

• Annual limitation of $100

− LossCo generates $3,000 in taxable income in 2017

− What is the order of the utilization of the NOLs?

• $200 of 2010 pre-change NOLs ($100 limit in 16 & 17)

• Entire $1,500 of post change unlimited NOLs

§382 – Ordering Rules

42


• Additional rules apply if LossCo is either a net

unrealized built in gain (NUBIG) or loss (NUBIL)

corporation

• Recognized built in gains (RBIG) increase the

annual limitation to the extent of NUBIG

• Recognized built in losses are subject to the annual

limitation as if they were net operating losses

• The recognition period is the sixty month period

following an ownership change

§382 – Built in Gains & Losses

43


NUBIG or NUBIL

• Overall determination of asset value as compared to tax basis with certain adjustments - §382(h)(3) & §382(h)(6)(C)

• RBIG or RBIL on an asset by asset approach - §382(h)(2)− RBIG & RBIL may be built-in items of income and deduction -

§382(h)(6)

• §382(h)(8) requires AGUB type approach for NUBIL asset value where 80% or more of company is acquired in a 12-month period− (h)(8) seems specific to NUBIL and is silent as to RBIL

− How does this impact bargain purchases? Is a §1060 approach required for RBIL? Could significantly impact the result.


44


NUBIG or NUBIL

• Only a NUBIG can have RBIG− RBIG limited to NUBIG

• Only a NUBIL can have a RBIL− RBIL limited to NUBIL

• If LossCo is neither, the annual limitation is not adjusted− NUBIG/NUBIL amount is considered to be zero if not greater

than the lesser of (a) $10 million or (b) 15% of the FMV of company assets immediately before the ownership change

• No netting of RBIG & RBIL incurred in a tax year

• A consolidated group can be both a NUBIG and NUBIL


45


NUBIG/NUBIL under Notice 2003-65:

• Determine amount realized if immediately prior

LossCo:

− Sold all assets (including intangibles) in an arm’s length

transaction at FMV to a party that assumed all liabilities

− Less deductible liabilities

− Add/Less §481 adjustments that would be triggered upon

a sale

− Add RBIL that would not be allowed under §§382 & 383

− Based upon S Corp §1374 BIG Regulations


46


§338 Method:

• Hypothetical §338 transaction

− Determine AGUB based upon value of equity on the date

of change

• In determining RBIG & RBIL LossCo looks to

income and deductions that would have occurred in

a §338 transaction and compare to actual tax items

− Including depreciation & amortization


47


§338 Method:

• Adopts “wasting asset” approach

• Depreciation & amortization in excess of (or below)

regular tax that would have occurred under a §338

transaction is treated as RBIG (or RBIL)

• Treats installment sale gains realized during the

recognition period and RBIG even if recognized

outside the recognition period


48


Example:

• Corporation X has a §382 ownership change on

1/1/2018

• $20M of equity value

• $180M of debt

• $50M of tax basis in the Company’s assets (no tax

basis in intangibles)

• Assume 2% AAFR (§382 limit w/o NUBIG is

$400k/year)

• Annual limit is $10.4M/year with application of

Notice 2003-65


49


Question: Is the §965 income inclusion RBIG for purposes of §382?

• The CFC is not being sold and so the FMV and basis of the asset would not appear to factor into whether there was a recognized built-in gain− FMV vs basis would be included in the NUBIG calculation

in the event of a sale

− However is the inclusion a built-in item of income?

− Based upon a plain reading of §382(h)(6) the income inclusion would not appear to represent a built-in item of income

TCJA: §§965 & 382

50


§338 approach:

• “The 338 approach identifies items of RBIG and

RBIL generally by comparing the loss corporation's

actual items of income, gain, deduction, and loss

with those that would have resulted if a §338

election had been made with respect to a

hypothetical purchase of all of the outstanding stock

of the loss corporation on the change date (the

"hypothetical purchase").”

TCJA: §§965 & 382 and Notice 2003-65

51


Actual item of income:

• §965 income pick-up in 2017 based upon

cumulative E&P

Income as-if §338:

• What would cumulative E&P have been under the

applicable §965 rules had a §338 election occurred

on the CFC as of the ownership change date?

TCJA: §§965 & 382 and Notice 2003-65

52


Example 1:

• Calendar year T undergoes an ownership change in October 2017

• In 2017 T must include $50M in §965 income from CFC − This is the actual item of income $50M

• Assuming cascading §338 elections then CFC would only have E&P from October through the §965 applicable date: assume zero− Hypothetical item is $0

• It would appear reasonable to argue that the $50M of income is a built-in item of income irrespective of the CFC value and basis

TCJA: §§965 & 382 and Notice 2003-65

53


Example 2:

• Calendar year T undergoes an ownership change in January 2015

• In 2017 T must include $50M in §965 income from CFC − This is the actual item of income $50M

• Assuming cascading §338 elections then CFC would have E&P from January 2015 through the §965 applicable date: assume $25M− Hypothetical item is $25M

• It would appear reasonable to argue that the $25M of income is a built-in item of income irrespective of the CFC value and basis

TCJA: §§965 & 382 and Notice 2003-65

54


What about NUBIG:

• T has FMV of assets $700M and $50M NUBIG as calculated under Notice 2003-65

• Assuming the $50M inclusion is RBIG the annual limitation is increased by $50M for 2017

• What about hypothetical amortization? With the RBIG in 2017 there is no additional RBIG that can be claimed

• Should NUBIG as defined in Notice 2003-65 be adjusted to include the $50M?

TCJA: §§965 & 382 and Notice 2003-65

55


§163(j) & §382


• §163(j) carryovers treated as an NOL -§§382(k)(1)/(d)(3)− Attribute under §381(c)(20)

− §382 limit is not increased under TCJA despite the fact that even more items are now subject to it

• At what point would a company become a loss company?− Would appear to be the first day of the first tax year where

there is a carryforward• “Such term shall include any corporation entitled to use a

carryforward of disallowed interest”

• You are not entitled to use the carryforward in the year incurred

• Proposed regulations appear to hold that it is the first day of the first year that a carryover is created

§163(j) & §382: Proposed regulations

57


• §163(j) and CODI

− §108(e)(2) excludes from CODI liabilities that have not

been deducted and which payment would result in

deduction

− §163(j) does not appear to fall within this section

• Consider whether cancellation if I/C debt of a solvent related

party now creates CODI that will never be deducted

• Proposed regulations do not appear address this

issue


58


• §163(j) and CODI (cont.)− §108(b) lists attributes subject to reduction for an

insolvent or bankrupt entity• §163(j) interest carryover is not listed as an attribute

• What is the risk? Could attributes such as asset basis become subject to reduction while leaving deferred interest carryovers untouched?

• Is there a benefit to such a position? What about black hole CODI?

• If deferred interest is not an attribute and you have black hole CODI could you retain the carryover interest?

• Do either of these positions seem reasonable?

• Proposed regulations appear silent on this issue


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• §382 application to “old” §163(j) deferral?− Generally deferred until final regulations

• §382 and closing of the books election: Interest expense not allowed to be allocated under closing of the books− Do not need to calculate ATI pre and post as a result

• SRLY/382 overlap rule adopted

• Ordering rules for §382− After RBILs and capital losses but before NOLs

− Subject to application of current year interest calculation shown on the next slide


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Ordering rules with current and deferred interest:

• Assume that X, a stand-alone C corporation, has $40x of disallowed business interest expense carryforwards and $30x of NOL carryovers from Year 1, both subject to a section 382 limitation of $35x. In Year 2, X has $50x of current-year business interest expense and a section 163(j) limitation of $45x.

• Under the rule in proposed §1.163(j)-5(b), X would use $45x of its current-year business interest expense and none of its disallowed business interest expense carryforwards, thus freeing up its section 382 limitation for its NOL carryovers..


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• Single consolidated limitation

• Appears to exclude intercompany interest for FEDERAL TAX

• Consolidated tax return calculation: Tracing approach not adopted1. Determine if current year limitation applies on a consolidated

level

2. If yes, then separate company offset for interest income and floorplan financing

3. If yes to 1 and after 2, deduct pro-rata similar to NOL utilization

4. If excess ATI and carryover interest from prior years then utilization of member deferred carryover as follows:

Section 163(j) & §382: Proposed regulations

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Consolidated utilization:

• P and S group with §163(j) limitation of $200x for the year

• Current-year business interest expense deducted is $100x

• P and S have $140x and $60x disallowed business interest expense carryforwards from the prior year that are not otherwise subject to limitation (for example, under section 382).

• Result: − P would be allowed to deduct $70x of its carryforwards (($140x /

($60x + $140x)) x $100)

− S would be allowed to deduct $30x of its carryforwards from Year 1 (($60x / ($60x + $140x)) x $100)


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• Carryover appears to be an attribute of the

subsidiary similar to an NOL and §1.1502-21

− Intercompany notes could have very different treatment

than third party debt in looking at attributes leaving a

group

• Application of §382 to §163(j) of an S corp

− How does this impact application to S corps more

broadly?


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§382 & the Next Day Rule


• For acquistions of corporations (Targets) by a consolidated group or from a consolidated group, Reg. § 1.1502-76 governs the dates group membership begins and ends

• It also provides rules for acquisition-date income and deduction items − Proposed regulations issued in 2015 would, if adopted, make

significant changes to rules applicable to acquisition date items

• Elimination of NOL carryback provisions has caused some to reasses this position as it relates the M&A costs

Next Day Rule

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• Target’s pre-acquisition tax year generally terminates at the end of the acquisition

date for non-S corps (a/k/a “end of the day rule”)

• Target’s post-acquisition consolidated group membership (or separate return

year) begins on the next day

Next Day Rule – Date of Entering or Departing Group

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• General rule: Items occurring on the acquisition date are allocated to the pre-

acquisition year

• Exception: allocated to the next day (and thus to the post-acquisition year) under

the “next day rule”

− Acquisition date items are treated as occurring on the

next day if “properly allocable” to the portion of the day

after the acquisition transaction.

− Whether a transaction is properly allocable to the portion

of the acquisition date is respected if the allocation is

“reasonable” and consistently applied by all persons

affected by it

Next Day Rule – Income and Deduction Items

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• 2015 proposed regulations would make the next day rule less flexible − Over 3 years old at this point

− Prior TAM and GLAM follow the intent described in the proposed Regs

• If finalized, would eliminate the ability to treat the success-based fees and compensation that become fixed at the closing

• Changes in rules related to S Corporations – “previous day” rule

• Where do we stand today?− Consider ASC740 implications and understand the audit firm’s

position

Next Day Rule – Proposed Regulations

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