Editor: Howard Wagner, CPA
Now that net operating loss (NOL) carryforwards are unlimited for tax years beginning after Dec. 31, 2017 (see the law known as the Tax Cuts and Jobs Act, P.L. 115-97, §13302), practitioners should be rethinking the use of the waiver of NOL carryforwards under Regs. Sec. 1.1502-32(b)(4) in acquisitions of a company with NOLs by a member of a consolidated group.
The general rule of Regs. Sec. 1.1502-32 is that NOLs of the acquired subsidiary reduce the stock basis of the subsidiary when the NOL is used to offset income of the consolidated return group or when the NOL expires.
Example 1: A member (P) of a consolidated group pays $50 million cash to acquire 100% of the stock of a target corporation (T), and T joins P's consolidated group. At the time of the acquisition, T has $50 million of pre-2018 NOLs. After the application of Sec. 382, P's consolidated group estimates it will be able to use $15 million of the acquired NOLs before they expire. Absent the waiver, P will ultimately reduce its basis in T by the entire $50 million of NOLs — $15 million when used to offset income and $35 million upon expiration of the unused NOLs.
The waiver is available in qualifying cost-basis transactions and transactions other than qualifying cost-basis transactions. Under Regs. Sec. 1.1502-32(b)(4)(ii)(A), a qualifying cost-basis transaction is the purchase (i.e., a transaction in which basis is determined under Sec. 1012) by members of the acquiring consolidated group (while they are members) in a 12-month period of an amount of T's stock satisfying the 80%-vote-and-value requirements of Sec. 1504(a)(2). The application of the waiver in a qualifying cost-basis acquisition for a stand-alone corporation is relatively straightforward. P can elect to waive the $35 million of NOLs that it does not expect to use to avoid a corresponding basis reduction in the acquired subsidiary when the unused NOLs expire.
A nonqualifying transaction is any other transaction in which T becomes a member of P's consolidated group under Regs. Sec. 1.1502-32(b)(4)(ii)(B). In this situation, an election to waive the NOL carryforward of T is deemed to occur immediately before T joins the consolidated group.
Example 2: Assume the same facts as Example 1, but the acquisition is a tax-free stock acquisition of T with a carryover basis in T's stock of $60 million. A waiver of $35 million of NOLs would reduce the basis in T to $25 million. Notably, in the case of the acquisition of T by a lower-tier consolidated group member, the reduction in basis does not tier up to the acquiring subsidiary. Assume the parent of a consolidated group owns 100% of the stock of a first-tier subsidiary, which acquires T. When the waiver election is made and T's basis is reduced by $35 million, the basis reduction does not tier up and reduce the parent's basis in the first-tier subsidiary.
In these situations, the basis reduction is limited to the lesser of the waived NOL or the net inside tax basis in assets, which is basis in assets plus NOLs after the waiver, less liabilities. For simplicity, the remainder of this discussion assumes that any basis reduction is not limited by the net inside basis.
Special rules apply if the target for which the loss waiver is made is a subsidiary in a chain of acquired corporations.
Example 3: A member of the purchasing consolidated group purchases all of the stock of A; A owns all of the stock of B, and B owns all of the stock of target (T). T becomes a member as a result of the acquisition of A, and a waiver of T's NOLs is made by the acquirer. When the election is made (whether in a qualifying cost-basis transaction or in a nonqualifying transaction), the NOL waived tiers up as a basis reduction to B. In a qualifying cost-basis transaction, no further adjustment is made to the acquired stock basis in A. However, if the chain is acquired in a nonqualifying transaction, the deemed basis reduction also tiers up to A.
The election to waive NOLs of the acquired subsidiary must be made in a separate statement titled, "ELECTION TO TREAT LOSS CARRYOVER OF [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF [subsidiary]] AS EXPIRING UNDER §1.1502-32(b)(4)." The election is made by including the statement on or with the acquiring consolidated group's income tax return for the year the acquired subsidiary becomes a member. A separate statement must be made for each member whose loss carryover is being waived. The statement must include the following information:
- The amount of each loss carryover deemed being waived (or the amount of each loss carryover deemed being retained, with any balance of any loss carryovers deemed to be waived); and
- The basis of any stock reduced as a result of the waiver.
With the unlimited carryforward of NOLs starting in tax years beginning on or after Dec. 31, 2018, acquirers will need to rethink the waiver of NOLs and will likely choose to only make a waiver of pre-2018 NOLs. Using the previous examples, assume T had $32 million of pre-2018 NOLs and $18 million of NOLs with unlimited carryforward. Assume further that the acquirer believes utilization of the pre-2018 NOLs is expected to be $15 million. The acquirer should waive the $17 million of pre-2018 NOLs that it does not expect to use to avoid the basis limitation. The waiver should not be made for the 2018 NOLs of $18 million, as these will never expire and will never reduce basis upon expiration.
Howard Wagner, CPA, is a partner with Crowe LLP in Louisville, Ky.
For additional information about these items, contact Mr. Wagner at 502-420-4567 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Crowe LLP.