On November 6, Congress passed, and President Obama signed, legislation extending the period to which net operating losses sustained in 2008 or 2009 may be carried. As a result, the NOLs incurred in either year (but not both) may be carried back to the fifth taxable year preceding the taxable year in which the NOL was suffered.1 Traditionally, the NOLs may be carried back only two years.
There are a few exceptions written into the new tax law with which companies should be familiar: two that are spelled out in the provisions and one that requires a little more digging into tax law from the 1980s that relates to the RJR Nabisco leveraged buyout and so-called corporate equity reduction transactions, or CERTs.
Before diving into the more obscure tenet, consider the mandates written into the new law. First, it states that not more than 50% of the taxable income earned in the fifth preceding tax year may be offset by the NOL carryback. In addition, the benefits of the new law do not extend to companies that took money from the government — via the Troubled Asset Relief Program — to prop up their failing business. That means that the NOL extension does not apply to companies that sold equity and/or warrants to the Treasury Department in exchange for cash as part of the Emergency Economic Stabilization Act of 2008, which established TARP. This is the case even if the company has already paid back its TARP money in full.
Looking closer at the tax code, it is also apparent that the new carryback law interacts with other provisions that were originally passed to prevent companies from using the NOLs to fund a portion of their leveraged buyouts. Indeed, the so-called CERT provisions will place limitations on the unfettered carryback of the “applicable NOLs,” based on Section 172(b)(1)(E) of the code.
That section says that in most cases, if there is a CERT and an “applicable corporation”2 has a CERIL (corporate equity reduction interest loss) for any “loss limitation year,”3 then the CERIL shall be an NOL carryback to the taxable years described in Section 172(b)(1)(A).4 However, there’s a catch: the CERIL is an NOL carryback except when the loss shall not be carried back to a taxable year preceding the taxable year in which the CERT occurs.
“The so-called CERT provisions will place limitations on the unfettered carryback of the ‘applicable NOLs.’” — Robert Willens
For this purpose, the term CERIL means the amount of the NOL that exceeds the NOL for the tax year determined without regard to any “applicable interest deductions.” This latter term encompasses deductions allowed under the Internal Revenue Code for interest on the portion of indebtedness that can be allocated to a CERT. For this purpose, the onerous “avoided cost method” is employed to determine the amount of indebtedness properly allocable to the CERT.