The CPA Journal

NOL Clarifications: SRLY and Ceilings

By Ricky S. Proper, Senior Tax Manager, American Express Tax and Business Services, Inc.

In June 1999, the Treasury Department issued regulations that eliminated the need to apply the separate return limitation year (SRLY) rules in certain circumstances where IRC section 382 also applies. A SRLY is a tax year of a subsidiary (or subgroup) before it becomes a member of a consolidated group. The SRLY rules limit the use of losses and their carryovers to both consolidated and separate return years. Before these regulations, a SRLY limitation often arose when there was also a change of ownership (more than 50%) in the subsidiary that triggered IRC section 382. In response to criticism, the IRS eliminated SRLY restrictions in certain situations where there is an overlap with the change of ownership rules under IRC section 382.

In general, the new regulations would increase the amount of net operating losses (NOL) that a consolidated group could absorb. This change is effective for tax returns with an original due date after June 25, 1999. For a detailed discussion of the SRLY overlap rules, see “Acquisition of Loss Companies by Consolidated Groups,” by Randy A. Schwartzman and Donald A. Barnes, The CPA Journal, December 1999.

The SRLY overlap rules resulted in unfavorable tax consequences for subsidiaries acquired during a tax year of the consolidated group to which the new regulations applied but before their actual issuance on June 25, 1999 (the interim period). The Treasury Department indicated in Notice 2000-53 that it would issue regulations for an election that allowed a subsidiary which ceased to be a member of a consolidated group in the interim period to avoid the application of the overlap rules to NOLs and capital losses for the year it left the group. The election would only apply if the subsidiary were acquired through a qualified stock purchase (80% of the stock purchased within a 12-month period by a corporate purchaser). The election could only be made by the departing member and would have no impact on the consolidated return of the selling group. Until the final regulations are issued, a departing member may make the election by writing “Election Pursuant to Notice 2000-53” across the top of its first original or amended Form 1120 for the first taxable year after it ceases to be a member of the selling group.

Succession to NOLs

In certain tax-free reorganizations, the acquiring corporation succeeds to the net operating losses (NOLs) of the target corporation. Among the limitations on the acquiring corporation’s use of the target corporation’s NOLs is a ceiling rule [IRC section 381(c)(1)(B)] which states that the target corporation’s NOL deducted in the acquiring corporation’s first taxable year ending after the transfer is limited to the acquiring corporation’s post-acquisition taxable income. The acquiring corporation’s post-acquisition taxable income is defined as the taxable income (determined without regard to an NOL deduction) of its first tax year after acquisition multiplied by the number of days in the tax year after the date of acquisition and divided by the total number of days in the tax year.

For example, assume a calendar year taxpayer acquires a target corporation on April 30, 2001. The target corporation has an NOL carryover of $5000 and the acquiring corporation has $3000 of taxable income (before any NOL deduction) for tax year 2001. Under the rule, the acquiring corporation could use no more than $2014 ($3000 ¥ 245 days 365 days) of the target corporation’s NOL carryforward in tax year 2001.

Letter Ruling 2000-44003 addressed the application of the ceiling rule to alternative minimum tax (AMT) NOL carryforwards to clarify IRC section 381. The ruling looked to the legislative history of the 1986 Tax Reform Act to conclude that AMT NOL carryovers are subject to the ceiling rule of section 381(c)(1)(B). The IRS pointed out that the regular and AMT systems are parallel and that unless a statute states otherwise, any limitations that apply to the use of NOLs for regular tax purposes similarly apply for AMT purposes. Therefore, the ruling stated that the acquiring corporation could succeed to the target corporation’s NOL carryovers only if it were subject to IRC section 381.

Editors:
Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner

Robert H. Colson, PhD, CPA
The CPA Journal

This Month | About Us | Archives | Advertise| NYSSCPA

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

FEDERAL TAXATION