U.S. taxpayers looking to take advantage of net operating loss relief under the coronavirus stimulus bill may find themselves facing the difficult task of reconsidering previously taken return positions related to complicated transition tax calculations.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) modified IRC section 172 to address liquidity issues arising from the COVID-19 pandemic by temporarily repealing the 80 percent NOL limitation and allowing deductions for loss carryovers and carrybacks to fully offset taxable income for tax years beginning before January 1, 2021. It also allows companies to carry back losses arising in tax years from 2018 through 2020 for up to five years before the year of the loss.
Raymond Stahl of EY noted that the “quickie” refund procedures made under Form 1139, "Corporation Application for Tentative Refund," were generally not available when carrying NOLs to and from a transition tax year. Rather, a taxpayer would need to file an amended return, he noted.
“Filing amended returns generally requires taxpayers to reconsider some of the positions that they took on those returns, including positions with respect to a lot of the complex aspects of the section 965 analysis, many of which were addressed in regs that were only finalized after taxpayers filed their returns,” Stahl said on an EY webcast April 10.
Stahl until recently was special counsel to the IRS associate chief counsel (international) and worked as the principal drafter for much of the transition tax guidance.
Under section 965, the Tax Cuts and Jobs Act imposes a one-time transition tax — 15.5 percent for cash positions and 8 percent for other amounts — on U.S. shareholders’ share of a specified 10-percent-owned foreign corporation’s deferred earnings and profits. The IRS issued final regs (T.D. 9846) on the transition tax in January 2019.
Still No Refunds
Section 965(h) may present another roadblock for taxpayers seeking refunds, Stahl said. “Despite the fact that a taxpayer has a lower tax liability in the transition tax year, it will often be the case that a taxpayer can’t receive a refund for that year. I think that’s going to come as a surprise to a lot of people, considering [that] the goal of the NOL provision is to provide liquidity,” he said.
Under section 965(h), taxpayers may elect to pay their transition tax liability in eight annual installments: 8 percent of the liability for the first five installments, 15 percent for the sixth installment, 20 percent for the seventh, and 25 percent for the eighth.
Bound by the provisions under sections 6402 and 6403, the IRS has said it cannot legally issue a refund to a taxpayer until all transition tax has been paid, but Stahl said he hopes that position will change.
An earlier draft provision in coronavirus legislation that did not end up in the final bill would have amended section 965(h) to clearly allow for refunds on overpayments of the transition tax for taxpayers who elected to pay the tax in installments.
Sneaking in Substantive Guidance
Companies may make a section 965(n) election not to apply their NOL deduction to their transition tax liability and instead, for example, apply foreign tax credits that they might otherwise be unable to use.
The CARES Act’s NOL provision states that if taxpayers carry back losses to a tax year that includes section 965 income, they will be deemed to have made the section 965(n) election for that year. Thus, taxpayers won’t be allowed to apply their NOL deduction to offset their transition tax liability.
But Stahl noted that the act “has some interesting language” that needed clarification, pointing to the rule that the deemed election is made “with respect to each such taxable year.”
“That language is pretty broad and raises the question 'If I didn’t make the [section] 965 election originally, and I carry an NOL back to a transition year, what exactly am I electing?'” Stahl said. “Am I making the election only for the new NOL carryback or does it also apply to other losses that I didn’t intend to defer?”
As an “extreme example,” Stahl posited a taxpayer that in 2017 had $100 of transition tax income that was offset by $90 of an NOL carryforward from 2016. If the taxpayer carried back $1 of NOLs to the transition tax year under the CARES Act, it had been an open question whether it would have been deemed to have retroactively made a section 965(n) election so that it would now owe transition tax on the previously offset $90.
Stahl pointed to guidance issued April 9 under Rev. Proc. 2020-24, 2020-17 IRB 1, that addresses the issue for companies that carry back NOLs to a section 965 inclusion year. That guidance states that the deemed election applies only for NOL carrybacks made under the CARES Act. While that may mean it only applies to $1 in his example, Stahl said some taxpayers would have liked to be able to retroactively make the section 965(n) election. Late elections are not allowed, however.
Marjorie Rollinson of EY also took note of the revenue procedure's position. “Some of us would say that [the IRS] snuck a little bit of substantive guidance into the revenue procedure,” Rollinson said, noting that it does not carry the same authority as regs. “But that is their view, and that is apparently how they will be instructing the field to audit returns.”