INSIGHTS AND RESOURCES
Net operating losses: One size does not fit all
Rules often unclear, vary by state
INSIGHT ARTICLE |
Authored by RSM US LLP
This article was originally published on June 02, 2017
Understanding a target’s net operating losses (NOLs) is an important part of due diligence, but simply being aware of the state implications is not enough. An analysis of the limitation on federal NOL’s without analysis of state attributes may result in misstatements of the value of deferred tax assets and state income tax exposure for the taxpayer.
Internal Revenue Code (IRC) section 382 limits a company’s ability to use NOLs after a corporation is deemed to have an ownership change. Similar to the federal NOL limitations, the majority of states also place limitations on the NOL usage that may be more or less stringent than the federal limitation. Many states do not conform to section 382, and instead rely on completely separate tests to determine if NOLs can be utilized after an ownership change. However, many businesses fail to analyze the impact of significant transactions on state NOLs. Businesses should consider which state NOLs are significant to the business and consider the potential loss or limitation of an NOL before mergers or acquisitions occur. Companies should strive to understand the state NOL profile before entering into acquisitions, reorganizations or other material transactions, and consider opportunities to modify proposed deal structures to maximize the value of state NOLs.
If a federal section 382 study has been conducted, taxpayers often oversimplify the state NOL limitation by taking the federal NOL multiplied by the state apportionment rate and booking the resulting figure. That analysis is technically correct in some, but not all states. Businesses that take the “one size fits all” approach can result in adjustments on audit, even for tax years otherwise outside the statute of limitations because some states allow the modification of NOLs utilized in open years. For example, consider a taxpayer that takes the federal section 382 limitation multiplied by the state apportionment percentage for a 2005 acquisition and applies that method to all states. In 2015, upon audit the state disallows the NOLs in the current years because the state does not conform to section 382. The NOLs are lost, because the years where the company could have used the benefit are already closed under statute.
Before using an approach that may have NOLs expiring and financial statement valuation misstatements there are some key questions that should be asked.
- Are the NOLs completely lost due to the change event?
- Is there a way to structure the deal which provides the best use of state NOLs?
- For states that do not conform to section 382, or may have additional rules on NOL utilization such as state specific separate return limitation year considerations, are those properly taken into account?
- In states where section 382 does apply, does the limitation apply on a pre- or post-apportionment basis?
- If the state applies a post-apportionment methodology, does section 382 apply based on the year of ownership change or is the company required to recalculate each year?
- If the business is acquiring a consolidated group of companies, while federal section 382 limits might be calculated at the group level, will any of the states require computations on a company-by-company basis?
- Are there any state differences in how the section 382 is calculated based on state modifications?
While some states have defined how section 382 applies or have otherwise described NOL carryforward limitations by statute, in other states, companies must determine treatment based on case law. There is however, a silver lining. Because of the disparity between federal and state treatment of NOLs, you may have increased or accelerated NOL utilization in some states that do not conform to section 382. It is important to be proactive when it comes to state NOLs and significant corporate transactions, and to collaborate with RSM’s state and local tax professionals to properly document the positions to maximize opportunities and mitigate risks.
Call us at +1 213.873.1700, email us at firstname.lastname@example.org or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by /content/mcgladrey/en_US/about/profiles/Arnold-Matt, Mo Bell-Jacobs, Nicole Rooney and originally appeared on 2021-09-21.
2021 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Vasquez & Company LLP can assist you, please call +1 213.873.1700.
Subscribe to receive important updates from our Insights and Resources.