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On July 2, 2020, the Treasury Department (Treasury) and the IRS released two regulation packages, each under IRC Section 1502: proposed regulations (REG-125716-18) (Proposed Regulations) and temporary regulations (TD 9900) (Temporary Regulations) (which also serve as part of the Proposed Regulations). The Proposed Regulations generally address the absorption of consolidated net operating loss (CNOL) carryovers and carrybacks applicable to consolidated groups under the Tax Cuts and Jobs Act of 2017 (TCJA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020.

As general background, IRC Section 172(b)(1)(D), enacted by the CARES Act, allows net operating losses (NOLs) arising in tax years beginning after December 31, 2017, and before January 1, 2021 (e.g., NOLs incurred in 2018, 2019 or 2020 by a calendar-year taxpayer) to be carried back to each of the five tax years preceding the tax year in which the NOL arose. In doing so, it temporarily overrides the repeal by the TCJA of the ability of most taxpayers to carry back NOLs. The CARES Act also temporarily removed the TCJA-enacted 80% taxable income limitation on the absorption of NOLs until tax years beginning after 2020 (the 80% limitation).

This Alert specifically addresses (1) the guidance in the Proposed Regulations on applying the 80% limitation and amended carryback rules to consolidated groups that include one or more nonlife insurance companies and (2) proposed amendments to Treas. Reg. Section 1.1502-47, applicable to consolidated groups that include one or more life insurance company members.¹

Background

Under TCJA amendments to IRC Section 172, the 80% limitation does not apply to nonlife insurance companies. In addition, NOLs generated by nonlife insurance companies (as well as farming losses) have special carryback and carryforward rules.

The Proposed Regulations address the application of the 80% limitation for tax years beginning after 2020 to consolidated groups containing one or more nonlife insurance companies and one or more life insurance and/or non-insurance company members. The Proposed Regulations would also update Treas. Reg. Section 1.1502-47 (addressing consolidated groups that join in filing a life/nonlife consolidated return) to reflect statutory changes since its promulgation.

The Proposed Regulations generally would apply to losses arising in tax years beginning after the publication date of the Treasury Decision adopting the regulations as final. Taxpayers deducting CNOLs arising in tax years beginning after 2017, however, may rely on the Proposed Regulations (if applied consistently and in their entirety).

Application of the 80% limitation to consolidated groups

For tax years beginning after 2020,² the Proposed Regulations would apply the 80% limitation on the absorption of NOL carrybacks and carryovers based on the status of the entity whose income would be offset by the losses, rather than the status of the entity whose loss is being absorbed. As a result, the amount of a CNOL absorbed in a tax year beginning after 2020 would depend on the extent to which the income-producing member is subject to the 80% limitation.

Under the Proposed Regulations' approach, absorption of a post-2017 CNOL that is carried back or forward within a consolidated group composed of one or more nonlife insurance companies and one or more life insurance or non-insurance companies would entail determining the amount of a residual income pool (composed of income of members that are not nonlife insurance companies) and a nonlife income pool (composed of income of members that are nonlife insurance companies).³

The residual income pool would equal the lesser of:

• The aggregate amount of post-2017 NOLs carried to that year

or

• 80% of the excess of the group's consolidated taxable income (CTI) for that year that exceeds the aggregate amount of pre-2018 NOLs that are carried to that year and allocated to the positive net income of members other than nonlife insurance companies

CTI would be determined without regard to any deductions under IRC Sections 172, 199A and 250, and without regard to any income, gain, deduction or loss of members that are nonlife insurance companies.

The nonlife income pool would equal 100% of the group's CTI for the year, less the aggregate amount of pre-2018 NOLs that are carried to that year and allocated to the positive net income of nonlife insurance company members. CTI for this pool would also be determined without regard to any deductions under IRC Sections 172, 199A and 250, and without regard to any income, gain, deduction or loss of members that are not nonlife insurance companies.

For purposes of computing the residual income pool and the nonlife income pool, pre-2018 NOLs would be allocated pro-rata between the residual and nonlife income pools based on the relative amounts of positive net income in each pool in the consolidated return year to which the loss is being carried (i.e., the two pools are computed using a subgroup approach).

If the consolidated group's nonlife insurance company members have an aggregate loss in the consolidated return year to which a loss is being carried and its other members have aggregate taxable income in that year, the group's post-2017 CNOL deduction limit would equal the lesser of:

• The aggregate amount of post-2017 CNOLs carried to the year

or

• 80% of the excess of the group's CTI (determined without regard to the deductions under IRC Sections 172, 199A and 250), that exceeds the aggregate amount of pre-2018 NOLs carried to that year (i.e., the 80% limitation would apply to all CTI for the year)⁴

In contrast, if the consolidated group's nonlife insurance company members have aggregate taxable income in the consolidated return year to which a loss is being carried and its other members have an aggregate loss in that year, up to 100% of the CTI for the year could be offset by post-2017 CNOL deductions (because the group's net income was generated by the nonlife insurance company members). The group's post-2017 CNOL deduction limit would equal the group's CTI, less the aggregate amount of pre-2018 NOLs carried to that year.

The Treasury Department and the IRS considered an alternative, more comprehensive approach that would have required a group to first offset income and loss items within a pool of nonlife insurance companies and a pool of other members, applicable to tax years beginning after December 31, 2020. This alternative approach would have applied a pooling concept beyond merely determining the group's post-2017 CNOL deduction limit. It also would have required allocating the group's CTI between the income from operations of its nonlife insurance company members, which can be offset fully by CNOL deductions, and the income from operations of its other members subject to the 80% limitation. The alternative approach would have adopted a threshold computational step under which the principles of Treas. Reg. Section 1.1502-21(b)(2)(iv)(B) would apply to offset the income and loss items solely among members that are nonlife insurance companies, with the remaining members of the group being subject to a parallel offset. Following that initial offsetting, the principles of Treas. Reg. Section 1.1502-21(b)(2)(iv)(B) would apply to allocate a post-2017 CNOL among all group members with taxable income.

The Treasury Department and the IRS are aware that the Proposed Regulations' CNOL absorption approach may create an incentive in some circumstances for a consolidated group to break up a member into separate income and loss generating members to alter how a CNOL is allocated among members (e.g., in a year beginning after December 31, 2020, break up a nonlife insurance company to enhance its CNOL allocation, and in turn the amount of the CNOL carryback), but concluded that the administrative simplification outweighed the potential tax policy concerns. The Treasury Department and IRS have specifically requested comments on the approach taken in the Proposed Regulations and the proposed alternative approach.

Recomputing CNOLs attributable to each member

The Proposed Regulations do not amend existing rules for allocating a CNOL within a consolidated group. However, Prop. Treas. Reg. Section 1.1502-21(b)(2)(iv)(B)(2) would implement a special methodology for recomputing a member's portion of a CNOL if the CNOL is absorbed on a non-pro rata basis. For example, the nonlife insurance member's portion of a CNOL may be reduced at a different rate than the portion of the CNOL allocated to other members when the nonlife insurance member's CNOL portion is absorbed in a prior return year. This is because CNOLs allocable to nonlife insurance members may be carried back, but CNOLs arising in tax years beginning after December 31, 2020 and attributable to other members may only be carried forward.

Similarly, the application of the attribute reduction rules in Treas. Reg. Sections 1.502-11(b) and (c), 1.1502-28 and 1.1502-36(d), and the carryback of separate return limitation year NOLs could result in non-pro rata absorption of a member's portion of a CNOL. The proposed recomputation rules would redetermine the percentage of the CNOL attributable to each member by dividing the remaining CNOL attributable to the member at the time of the recomputation by the sum of the remaining CNOLs attributable to all of the remaining members at the time of recomputation, effectively reducing the member's portion of CNOL that was actually absorbed.

The Proposed Regulations also create new rules for allocating special status losses (e.g., farming losses). Under these rules, a CNOL that is a special status loss is allocated to each member separately based on the percentage of the CNOL attributable to the member, without regard to whether the member actually incurred the specific expenses or engaged in the specific activities that gave rise to the special status loss. This rule does not apply to farming losses incurred in tax years beginning after December 31, 2017, and before January 1, 2021.

Losses arising in separate return limitation year

The Proposed Regulations would create special rules applicable to losses arising in a separate return limitation year (SRLY).

If the 80% limitation applies in a tax year to a member whose carryovers or carrybacks are subject to a SRLY limitation (SRLY member), the amount of SRLY NOL that could be used by the consolidated group in that year would be limited to 80% of the balance in the cumulative SRLY register and available for offset if the SRLY member filed a separate return. The Proposed Regulations would modify the cumulative SRLY register rules to reflect the application of the 80% limitation. When the cumulative SRLY register is reduced to account for the consolidated group's absorption of any SRLY member's NOLs, the amount of the reduction would equal 100% (rather than 80%) of income that would be necessary to support the deduction by the SRLY member.⁵

Life-nonlife group updates

Significant changes to taxing insurance companies have been enacted since promulgation of Treas. Reg. Section 1.1502-47. As a result, various provisions of Treas. Reg. Section 1.1502-47 are outdated or preempted by statute. The Proposed Regulations would update Treas. Reg. Section 1.1502-47 to address these changes. Specifically, the Proposed Regulations would:

1. Remove paragraphs implementing statutory provisions that have been repealed (e.g., (1) Treas. Reg. Section 1.1502-47(k) and (l), which provides rules for calculating consolidated taxable investment income and the consolidated gain or loss from operations and (2) Treas. Reg. Section 1.1502-47(o), which provides rules for calculating the alternative tax imposed by IRC Section 1201 on consolidated capital gain (IRC Section 1201 was repealed by the TCJA))
2. Revise paragraphs implementing statutory provisions that have been substantially revised (e.g., Treas. Reg. Section 1.1502-47(f)(5) on the dividends-received deduction to reflect prior changes to IRC Sections 805(a)(4), 818(e)(2) and 832(b)(5)(B) and (g))
3. Update terminology and statutory references to account for other statutory changes (e.g., (1) remove references to former IRC Section 821 and mutual insurance companies, (2) replace references to IRC Section 802 with references to IRC Section 801 and (3) replace references to LO (loss from operations) to the NOL deduction under IRC Section 172)
4. Remove paragraphs that contain obsolete transition rules or that no longer apply because the effective dates in the current Treas. Reg. Section 1.1502-47 have passed

Implications

The Proposed Regulations clarify certain issues facing consolidated groups seeking to utilize the NOL carryback provisions of the TCJA and the CARES Act, including application of the carryback rules and the 80% limitation. The Proposed Regulations also would provide much needed updates to Treas. Reg. Section 1.1502-47 (although other issues pertinent to the life-nonlife group are still being studied by the Treasury Department and IRS for purposes of potential future guidance).

Additionally, adoption of the Proposed Regulation's approach to absorption of CNOLs by groups that include one or more nonlife insurance companies, as well as one or more life insurance and/or non-insurance companies, reduces compliance costs relative to the alternative approach considered by the Treasury Department and the IRS, and may provide opportunities for consolidated groups to improve near-term cash flow. Taxpayer profiles vary, however, and many taxpayers will benefit from more thorough, nuanced, quantitative decision-making with respect to any follow-on consequences of utilizing any portion of a CNOL attributable to their members.

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ENDNOTES

¹ For further details on the Temporary Regulations and other aspects of the Proposed Regulations, see Tax Alert 2020-1745.

² Prop. Reg. Section 1.1502-21(a)(2)(ii)(C) would not apply the 80% limitation to CNOL deductions arising in tax years beginning before January 1, 2021, in accordance with the CARES Act.

³ Treas. Reg. Section 1.1502-47 (including the proposed amendments that are part of the Proposed Regulations) would clarify that, in a life-nonlife group, the 80% limitation would be computed at the life-nonlife subgroup level, treating each subgroup as a group for that purpose. Thus, the residual pool, in the case of the life subgroup, would comprise solely the life insurance companies; for the nonlife subgroup, it would comprise all the non-insurance companies.

⁴ That would be the case, for example, when computing the 80% limitation of the life subgroup that is part of the life-nonlife group filing a consolidated return.

⁵ Consolidated groups with foreign insurance companies that have made a valid election under IRC Section 953(d) will be impacted. However, the proposed rules generally would not alter the ability to absorb losses of nonlife insurance company members that have made an election under IRC Section 953(d) because the income of such nonlife insurance companies is generally not subject to the 80% limitation.