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.
However, according to the tax code, applicable interest deductions should, in no event, exceed (1) the amount allowable as a deduction for interest paid or accrued by the taxpayer during the loss limitation year that is more than (2) the average of such amounts for the three tax years preceding the tax year in which the CERT takes place.
MSA and ED
The key term, CERT, refers to either a “major stock acquisition” or an “excess distribution.” A major stock acquisition encompasses a purchase that follows a corporate plan and involves the buying of stock in a target corporation that represents 50% or more (by either voting power or value) of the shares in the target. For this purpose, all acquisitions during any 24-month period are treated as pursuant to one corporate plan.
An excess distribution is defined as the excess of the aggregate distributions (including redemptions of stock) made during a tax year by a corporation with respect to its stock that is more than the greater of either 150% of the average of the distributions made during the three prior tax years5 or 10% of the value of the stock of the corporation as of the beginning of the tax year.
The CERT rules were enacted back in 1987, in the wake of the legendary RJR Nabisco leveraged buyout, at the behest of then–Sen. Lloyd Bentsen (D-Tex.). Bentsen was concerned that LBOs were being funded, at least in part, by tax refunds that the buyout sponsors could obtain from carrying back debt-induced NOLs of the target corporations. Moreover, these rules cover the case in which the target, to fend off an unwanted suitor, engages in a “self-LBO.” This explains the provision classifying excess distribution CERTs.
Therefore, if a corporation with the NOLs in 2008 or 2009 has recently participated in a CERT, the amount of the NOLs eligible for carryback under the expanded carryback privilege to years preceding the CERT year may be somewhat limited.
Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
1 See Sec. 172(b)(1)(H).
2 An applicable corporation is a C corporation that acquires stock, or the stock of which is acquired, in a major stock acquisition or a C corporation making distributions with respect to, or redeeming, its stock in connection with an excess distribution.
3 The taxable year in which the CERT occurs and each of the two succeeding years.
4 As expanded by Sec. 172(b)(1)(H).
5 The amount determined under the aggregate distribution and 150% of the average distribution shall be reduced by the aggregate amount of stock issued by the corporation during the applicable period in exchange for money or property other than stock of the corporation.