mergers & acquisition: lap two – nols and other … ipt annual conference 2017 ipt annual...

2017 IPT Annual Conference – Charlotte, North Carolina 2017 IPT Annual Conference – Charlotte, North Carolina

Mergers & Acquisition: Lap Two – NOLs and Other Issues

Jaye A. Calhoun Partner

Kean Miller LLP New Orleans, LA

[email protected]

Charles J. Moll III, Esq. Partner

Winston & Strawn LLP San Francisco, CA [email protected]


Overview

• State income tax laws often closely follow the federal income tax laws; however, when they don’t conform, special considerations can arise

• Significant areas of concern: – Conformity to Internal Revenue Code or Decoupling

• Filing Methodologies • Modifications to Tax Base • Tax Attributes

– Specific Issues with NOLs

• State Return-Filing Methods • NOL Apportionment Issues • In Reorganization Transactions • Impact of Federal Limitations • Apportionment of Fed Limitations

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IRC Conformity

• Starting Point: Line 28 vs. Line 30 • Types of General Conformity:

– Rolling Conformity – Static Conformity

• Even if a state conforms to the I.R.C., do they conform to judicial and administrative interpretations and guidance – States vary in their adoption of judicial and administrative

guidance. • Conformity may also be affected by both state and

federal constitutional concerns

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Statutory Decoupling – Filing Methodologies

• Federal Methodology vs. State Methodology • State Methodologies

– Separate Filing – Consolidated Filing – Combined/Unitary Filings

• State statutory, regulatory, and judicial guidance, including U.S. Supreme Court guidance

• Other issues can arise with unitary filings that have no federal counterpart:

– Instant Unity – Partnership Income – Worldwide/water’s edge reporting

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State Decoupling - Modification to Tax Base

• Interest on State/Municipal Obligations – Federal treatment allows deduction of all interest – State treatment varies:

• Complete federal conformity deduction of interest on own bonds, but not other states

• No deduction allowed for interest on own or other state bonds

• Depreciation – Federal rules often change – Bonus depreciation, Sec. 179 depreciation – For their own policy reasons, state may or may not follow

each federal change

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State Decoupling – Modification to Tax Base

• Dividends – Federal deduction for a certain percentage of dividends

received from other corporations – States generally follow the federal policy goal to limit double

taxation, but do so through different methods • Strict conformity • Only for wholly-owned subsidiaries • No deduction allowed

– Special rules apply to dividends received from controlled foreign corporations

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State Decoupling – Modification to Tax Base

• State Income Tax Deduction – Federal deduction for state and local income taxes – States often decouple from or limit this provision

• Limitation on deduction by only allowing a portion to be added back • Complete deduction requiring addback

• Section 199 DPAD – Federal Domestic Production Activities Deduction – Given scope, states have often decoupled from this

provision

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State Decoupling – Tax Attributes

• Capital Losses – Federal treatment

• Carryback 3 years • Carryforward 5 years

– States often decouple from this provision • Modifying time limits for carryforward/carryback • Disallowing carryback • Disallowing entire loss

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• Cancellation of Indebtedness Income (CODI) – Federal tax consequences of CODI:

• Receipt of CODI results in recognition of income unless statutory exclusion applies (e.g., CODI paid to discharge bankruptcy or insolvency)

– If income is excluded, the amount excluded is used to reduce federal tax attributes as “payment”: NOL’s first, then in order, general business credit, minimum tax credits, capital loss carryovers, basis of property, passive activity loss and credit carryovers, and finally, foreign tax credit carryovers

– Taxpayer can elect to reduce basis of depreciable assets first – IRC Section 108(i) allows deferral of income with no effect on tax

attributes – Lots of decoupling on 108(i)

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• Cancellation of Indebtedness Income (CODI) – State tax consequences of CODI:

• Nearly all states conform to the federal CODI rules, but the reduction for state tax attributes is far less consistent (e.g. IL has its own NOL reduction calculation)

• Nonconformity between state and federal asset basis or a disconnect between state and federal NOL reductions makes tracking attributes difficult

– To the extent a state NOL is considered to be different than a federal NOL, and a state does not have explicit guidance on reducing a state-specific attribute, a taxpayer may not have to reduce its state NOL tax attribute (NJ)

– However, that may lead to a larger reduction in the basis of its assets and in other tax attributes

– Similarly, in states where NOL is calculated on a post-apportioned basis, reduction in NOL attribute could be smaller than what would have been the case for federal tax purposes

• Only a few states explicitly provide for ordering rules when reducing tax attributes

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• Net Operating Losses – Federal treatment

• Carryback 2 years • Carryforward 20 years

– States often decouple from this provision, tying to starting point conformity

• Line 30 Starting point • Line 30 starting point, eliminating federal NOL, but providing for state

NOL • Line 28 starting point with separate state NOL

– Other Limitations • Some states employing the year of use methodology do not require

that the loss entity was doing business in the state during the year the loss was sustained - e.g., Virginia.

• States may limit percentages of NOLs that may be used for state purposes – e.g., Louisiana

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2017 IPT Annual Conference – Charlotte, North Carolina 2017 IPT Annual Conference – Charlotte, North Carolina 12

Specific Issues with NOLs

• Key Questions – To what extent, if any, does the state adopt the

IRC? – Line 28 or Line 30 of federal return (i.e., before or

after federal NOL deduction)? – Adoption of IRC §§ 172, 381, 382 and 384 – Should IRC §382 limitation be apportioned? – Adoption of federal SRLY rules? – State apportionment issues


Specific Issues with NOLs

• Specific Decoupling Issues – Many states “decouple” from federal carry

back and carry forward rules – Many states “decouple” with respect to

I.R.C. §108(i) issues • Nexus

– Is nexus required in the loss year? – Is nexus required in the year NOL

deduction is reported?

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Specific Issues with NOLs – State Return-Filing Methods

• Source of many federal/state differences – Separate – “1502 Consolidated” – generally follows

federal consolidated return regulations (“CRR”) • But most states do not adopt federal CRR

– Unitary Combined – most states do not adopt federal CRR

– Nexus Combined – some states adopt federal CRR (e.g., VA, IN, IA and DC)

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• NOLs and Unitary Combination – Is the NOL computation performed at the

unitary group level or the separate member level? • IL – NOL computation follows group

theory • CA – NOL computation follows separate

company theory

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• Due date for filing of separate company return – Regs. §1.1502-76(c)(2)

• SRLY E&P generally does not tier-up (but see reverse acquisition)

• Non-intercompany obligation becoming an intercompany obligation (Regs. §1.1502-13(g))

• Importation of loss attributes (Regs. §1.1502-91 et seq.) or SRLY consequences

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Specific Issues with NOLs – Apportionment Issues

• State Calculation of NOLs – Pre-apportionment

• Ex: NY, MO, NJ and VA – Post-apportionment

• Ex: CA, IL, PA and MA • Which Year’s Apportionment Factors Apply?

– Year loss incurred or the year NOL carry back or carry forward is utilized?

– Consider the impact of states converting to single sales factor?

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Specific Issues with NOLs – In Reorg Transactions

• NOLs and Corporate Reorganizations – Planning Tip: preserve NOLs – No carryover in an IRC §351 transaction – Importance of loss company’s survival in a

merger – Impact of deconsolidation (e.g., insertion of a

joint venture or partnership between parent and loss company) or de-combination on NOL

– Protection of NOLs in corporate restructuring transactions


Specific Issues with NOLs – Reorg Transactions

• Survival of NOLs – Survival of loss company required in some

states (e.g., MA, NJ, TN) – SRLY-type limits in other states (e.g., AZ) – Continuity of business enterprise may

apply (e.g., AL, AZ, CT, NC) – Business purpose may be required – No survival in some states (e.g., MT)


Specific Issues with NOLs – Federal Limitations

• Application of Federal Limitations – I.R.C. §382 limits ability of a “loss company” to

utilize its “pre-change losses” to offset “post-change income” following an “ownership change”

– Calculation of I.R.C. §382 limitation: • Value of Old Loss Co. X Long-term Tax-exempt

rate – State Conformity to I.R.C. §382

• Some expressly conform • Some impliedly conform • Some adopt their own specific

restrictions/limitations

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Specific Issues with NOLs – Federal Limitations

• Continuity of Business Enterprise Doctrine – Under this doctrine, carryovers are

allowed only to the extent there is a continuity of business enterprise between the pre- and post-merger entities (Libson Shops, Inv. v. Koehler, 353 U.S. 382 (1957)

– Some states my adopt statutory “continuity of business enterprise” rules

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Specific Issues with NOLs – Fed Limits and Apportionment

• Pre- and Post-Apportionment of I.R.C. §382 Limitation – Most states are silent on this issue – In AT&T v. Ala. Dept. of Rev. (6/30/06), the ALJ

held that the taxpayer was not required to apportion is I.R.C. §382 limitation for Ala. income tax purposes because the law was silent • Following the decision, Ala. Dept. of Rev.

adopted a reg. that requires taxpayers to apply limitation after apportionment

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Specific Issues with NOLs – Fed Limits and Apportionment

• Pre- and Post-Apportionment of I.R.C. §382 Limitation (cont.) – Other states specifically require taxpayers to

apportion their I.R.C. §382 limitation • Such laws generally severely restrict use of

pre-change NOLs – Questions arise as to whether taxpayers must

use apportionment in the year of the apportionment change, year in which the NOLs are being used, or the year each NOL was generated

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Questions?

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mergers & acquisition: lap two – nols and other … ipt annual conference 2017 ipt annual...

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