Question

When a group of corporations comes together to form an affiliated group for tax purposes, individual corporate members in the group may choose to file their own income tax return or file a group tax return; with an agreement of all the group members, they can elect to file a consolidated return. Imagine that a client is pursuing the acquisition of Corporation A that has a substantial net operating loss. Corporation B is a member of a controlled group and is currently included in a consolidated tax return that also has a net operating loss.

• Analyze the potential advantages and disadvantages of Corporation B’s acquisition of Corporation A and Corporation A’s subsequent inclusion in Corporation B’s consolidated tax return.
• Suggest the critical tax issues the client should consider in determining the deductibility of the net operating losses.
• Evaluate the impact of the Tax Cuts and Jobs Act (TCJA) on the net operating losses.

Answer 1

What Is a Net Operating Loss (NOL)

For income tax purposes, a net operating loss (NOL) is the result when a company's allowable deductions exceed its taxable income within a tax period. The NOL can generally be used to offset the company's tax payments in other tax periods through an Internal Revenue Service (IRS) tax provision called a loss carryforward.

How a Net Operating Loss (NOL) Is Used

A net operating loss (NOL) may be carried forward to offset taxable income in future years in order to reduce a company's future tax liability. The purpose behind this tax provision is to allow some form of tax relief when a company loses money in a tax period. The IRS recognizes that some companies' business profits are cyclical in nature and not in line with a standard tax year.

For example, a farming business may have significant profits and a large tax payment in one year, then incur a NOL in the next, followed by another profitable year. In order to smooth the tax burden, the loss carryforward provision allows for the NOL in the second year to offset taxes due in the third year.

Requirements for a Net Operating Loss Carryforward

Prior to the implementation of the Tax Cuts and Jobs Act (TCJA) in 2018, the Internal Revenue Service (IRS) allowed businesses to carry net operating losses (NOL) forward 20 years to net against future profits or backwards two years for an immediate refund of previous taxes paid. Because the time value of money shows that tax savings in the present are more valuable than in the future, the carryback method was the more beneficial choice. After 20 years, any remaining losses expired and could no longer be used to reduce taxable income.