IRS Proposed Rule: Consolidated Net Operating Losses

WASHINGTON, July 8 -- The Treasury Department's Internal Revenue Service has issued a proposed rule (26 CFR 1), published in the Federal Register on July 8, entitled: "Consolidated Net Operating Losses".

The proposed rule was issued by Douglas W. O'Donnell, Acting Deputy Commissioner for Services and Enforcement.

DATES: Written or electronic comments and requests for a public hearing must be received by August 31, 2020. Requests for a public hearing must be submitted as prescribed in the "Comments and Requests for a Public Hearing" section.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Justin O. Kellar at (202) 317-6720, Gregory J. Galvin at (202) 317-3598, or William W. Burhop at (202) 317-5363; concerning submission of comments or requests for a public hearing, Regina Johnson at (202) 317-5177 (not toll-free numbers).

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This notice of proposed rulemaking contains proposed amendments to the consolidated return regulations under section 1502 of the Internal Revenue Code (Code).

The proposed regulations provide guidance implementing recent statutory amendments to section 172 and withdraw and re-propose certain sections of proposed regulations issued in prior notices of proposed rulemaking relating to the absorption of consolidated net operating loss carryovers and carrybacks.

In addition, the proposed regulations update regulations applicable to consolidated groups that include both life insurance companies and other companies to reflect statutory changes.

These proposed regulations would affect corporations that file consolidated returns.

SUPPLEMENTARY INFORMATION:

In the Rules and Regulations section of this issue of the Federal Register, the IRS is issuing temporary regulations to permit consolidated groups that acquire new members that were members of another consolidated group to elect to waive all or part of the pre-acquisition portion of an extended carryback period under section 172 of the Code for certain losses attributable to the acquired members. The text of those temporary regulations also serves as the text of Section 1.1502-21(b)(3)(ii)(C) and (D) of these proposed regulations. The proposed and temporary regulations affect corporations that file consolidated returns.

Background

These proposed regulations revise the Income Tax Regulations (26 CFR part 1) under section 1502 of the Code. Section 1502 authorizes the Secretary of the Treasury or his delegate (Secretary) to prescribe regulations for an affiliated group of corporations that join in filing (or that are required to join in filing) a consolidated return (consolidated group) to reflect clearly the Federal income tax liability of the consolidated group and to prevent avoidance of such tax liability. See Section 1.1502-1(h) (defining the term "consolidated group"). For purposes of carrying out those objectives, section 1502 also permits the Secretary to prescribe rules that may be different from the provisions of chapter 1 of the Code that would apply if the corporations composing the consolidated group filed separate returns. Terms used in the consolidated return regulations generally are defined in Section 1.1502-1.

These proposed revisions implement certain statutory amendments made by Public Law 115-97, 131 Stat. 2054 (December 22, 2017), commonly referred to as the Tax Cuts and Jobs Act (TCJA). Specifically, section 13302 of the TCJA amended section 172 of the Code, relating to net operating loss (NOL) deductions, and sections 13511 through 13519 of the TCJA amended subchapter L of chapter 1 of the Code (subchapter L), relating to the taxation of insurance companies. These proposed regulations also implement further statutory amendments to section 172 of the Code made by the Coronavirus Aid, Relief, and Economic Security Act, Public Law 116-136, 134 Stat. 281 (March 27, 2020) (CARES Act). Additionally, these proposed regulations update regulations under section 1502 concerning consolidated groups that include life insurance companies and other companies (life-nonlife groups) to implement amendments under prior tax legislation.

I. Net Operating Loss Deductions

Prior to amendment by the TCJA, section 172(a) allowed a taxpayer to use its aggregate NOL carryovers and carrybacks to a taxable year to offset all taxable income in the taxable year, and section 172(b)(1) generally permitted taxpayers to carry back NOLs two years and carry over NOLs 20 years. The TCJA amended section 172 to provide new NOL deduction rules based on (i) the type of entity generating the NOL or using an NOL to offset income, or (ii) the character of the loss giving rise to an NOL. The CARES Act extended the carryback period for NOLs arising in a taxable year beginning after December 31, 2017, and before January 1, 2021. See part I.A of this Background. Both the TCJA and the CARES Act also made other changes to section 172 that are not pertinent to this notice of proposed rulemaking.

A. General NOL Rules

As amended by section 13302(a)(1) of the TCJA and section 2303(a)(1) of the CARES Act, section 172(a)(2) of the Code allows an NOL deduction for a taxable year beginning after December 31, 2020, in an amount equal to the sum of two factors. The first factor is the aggregate amount of NOLs arising in taxable years beginning before January 1, 2018 (pre-2018 NOLs), that are carried to such taxable year. The second factor is the lesser of (i) the aggregate amount of NOLs arising in taxable years beginning after December 31, 2017 (post-2017 NOLs), that are carried to such taxable year, or (ii) 80 percent of the excess (if any) of (I) taxable income computed without regard to any deductions under sections 172, 199A, and 250 of the Code, over (II) the aggregate amount of pre-2018 NOLs carried to the taxable year (this latter calculation, the 80-percent limitation). The 80-percent limitation does not apply to taxable years beginning before January 1, 2021. See section 172(a)(1). For any such taxable year, section 172(a)(1) allows an NOL deduction equal to the aggregate amount of NOL carryovers and carrybacks to such year. See id. Moreover, the 80-percent limitation does not apply to limit the use of pre-2018 NOLs. See section 172(a)(2)(A).

Section 13302(b) of the TCJA amended section 172(b) to generally eliminate NOL carrybacks but permit post-2017 NOLs to be carried over indefinitely. Section 2303(b) of the CARES Act further amended section 172(b) to require (unless waived under section 172(b)(3)) a five-year carryback for NOLs arising in taxable years beginning after December 31, 2017, and before January 1, 2021. See section 172(b)(1)(D)(i).

B. Special NOL Rules for Nonlife Insurance Companies

Section 13302(d) of the TCJA added sections 172(b)(1)(C) and 172(f), which provide special rules for insurance companies other than life insurance companies, as defined in section 816(a) (nonlife insurance companies, which commonly are referred to as property and casualty insurance companies or P&C companies). Under section 172(f), the 80-percent limitation does not apply to nonlife insurance companies. Therefore, taxable income of nonlife insurance companies may be fully offset by NOL deductions. In addition, under sections 172(b)(1)(C) and (b)(1)(D)(i), losses of nonlife insurance companies arising in taxable years beginning after December 31, 2020, may be carried back two years and carried over 20 years. (As noted in part I.A of this Background, losses arising in taxable years beginning after December 31, 2017, and before January 1, 2021, are carried back five years.) Thus, for taxable years beginning after December 31, 2020, the operative rules under section 172 effectively apply to nonlife insurance companies in the same manner as those rules applied prior to enactment of the TCJA.

C. Special NOL Rules for Farming Losses

Section 13302(c) of the TCJA amended the special rules for farming losses set forth in sections 172(b)(1)(F) and 172(h), as in effect prior to enactment of the TCJA. For purposes of section 172, a "farming loss" is the lesser of (i) the amount that would be the NOL for the taxable year if only income and deductions attributable to farming businesses (as defined in section 263A(e)(4) of the Code) were taken into account, or (ii) the amount of the NOL for that taxable year. See section 172(b)(1)(B)(ii). Under sections 172(b)(1)(B)(i) and (b)(1)(D)(i)(II), any portion of an NOL for a taxable year beginning after December 31, 2020, that is characterized as a farming loss is treated as an NOL that is carried back two years and, as provided in section 172(b)(1)(A)(ii)(II), is carried over indefinitely. Farming losses arising in taxable years beginning after December 31, 2017, and before January 1, 2021, are carried back five years. Section 172(b)(1)(D)(i).

II. Insurance Company Provisions

The TCJA also made several changes to subchapter L (which addresses the taxation of insurance companies) that are relevant to this notice of proposed rulemaking. First, sections 13511(a) and 13511(b) of the TCJA (i) struck section 805(b)(4), which generally denied life insurance companies the NOL deduction provided in section 172, and (ii) made a conforming amendment by striking section 810, which provided a deduction for operations losses for life insurance companies. As a result, effective for taxable years beginning after December 31, 2017, life insurance companies are entitled to an NOL deduction under the general rules of section 172. Second, section 13001(b)(2)(A) of the TCJA struck section 1201, which imposed a minimum tax on capital gains. Third, section 13514(a) of the TCJA struck section 815, which provided continued deferral of tax on policyholders surplus accounts. Fourth, under section 13514(d) of the TCJA, stock life insurance companies must pay the tax imposed by section 801 on the balance of any policyholders surplus accounts (determined as of the close of such company's last taxable year beginning before January 1, 2018) ratably over the first eight taxable years beginning after December 31, 2017.

Additionally, section 2303(b) of the CARES Act added a special rule for life insurance companies. Section 172(b)(1)(D)(iii) provides that, in the case of a life insurance company, if an NOL is carried back under section 172(b)(1)(D)(i)(I) to a life insurance company taxable year beginning before January 1, 2018, such NOL carryback shall be treated in the same manner as an operations loss carryback (within the meaning of section 810 as in effect before its repeal) of such company to such taxable year.

Because the repeal of section 810 is effective for losses arising in taxable years beginning after December 31, 2017, operations loss carryovers from taxable years beginning before January 1, 2018, continue to be allowed as deductions in taxable years beginning after December 31, 2017, in accordance with section 810 as in effect before its repeal by the TCJA. See Staff of the Joint Comm. on Tax'n, 115th Cong., General Explanation of Public Law 115-97, at 226 (Dec. 2018).

Final regulations applicable to life-nonlife groups under Section 1.1502-47 were published in the Federal Register on March 18, 1983. See 48 FR 11441 (March 18, 1983) (current life-nonlife regulations). In the years that followed that publication, other legislation also significantly altered the taxation of insurance companies.

Explanation of Provisions

I. Overview

These proposed regulations provide guidance for consolidated groups regarding the application of the 80-percent limitation, as originally enacted as part of the TCJA and subsequently amended by the CARES Act. These proposed regulations also provide guidance regarding the application of the NOL carryback provisions following enactment of the TCJA and the CARES Act. In addition, the proposed regulations withdraw and re-propose certain sections of proposed regulations issued under section 1502 in prior notices of proposed rulemaking that relate to the absorption of NOL carrybacks and carryovers. See part II of this Explanation of Provisions for a further discussion.

These proposed regulations also update Section 1.1502-47 to reflect certain changes to the insurance company rules made by the CARES Act, the TCJA, and prior tax legislation. See part III of this Explanation of Provisions for a further discussion. The Treasury Department and the IRS continue to study other issues pertinent to life-nonlife groups for purposes of potential future guidance.

II. Amendments to Section 1.1502-21

A. In General

Under section 172, as amended by the TCJA and the CARES Act, NOLs generated by certain members of a consolidated group (that is, nonlife insurance companies), as well as NOLs generated by certain business activity within a consolidated group (that is, farming losses), are subject to different rules than other NOLs in taxable years beginning after December 31, 2020. The proposed regulations implement these statutory rules with regard to affiliated groups of corporations that file consolidated returns.

B. Application of the 80-Percent Limitation

1. In General

Section 1.1502-21(a) defines the consolidated net operating loss (CNOL) deduction for any consolidated return year as "the aggregate of the net operating loss carryovers and carrybacks to the year." This section specifies that "[t]he net operating loss carryovers and carrybacks consist of (1) [a]ny CNOLs . . . of the consolidated group; and (2) [a]ny net operating losses of the members arising in separate return years." NOL carryovers and carrybacks to a consolidated return year are determined under the principles of section 172 and Section 1.1502-21. See Section 1.1502-21(b)(1). For example, losses permitted to be absorbed in a consolidated return year generally are absorbed in the order of the taxable years in which they arose. See id.

As discussed in part I.A of the Background, the 80-percent limitation on the use of post-2017 NOLs to offset taxable income (other than taxable income of nonlife insurance companies) applies to taxable years beginning after December 31, 2020. Consistent with longstanding provisions in Section 1.1502-21(b)(1), these proposed regulations generally implement the 80-percent limitation on a consolidated group basis by limiting a group's deduction of post-2017 NOLs for any such taxable year to the lesser of (1) the aggregate amount of post-2017 NOLs carried to such year, or (2) 80 percent of the excess (if any) of the group's consolidated taxable income (CTI) (computed without regard to any deductions under sections 172, 199A, and 250) over the aggregate amount of pre-2018 NOLs carried to such year. Thus, the amount allowed as a deduction for a particular consolidated return year beginning after December 31, 2020, equals the sum of (1) pre-2018 NOLs carried to that year (see section 172(a)(2)(A)), and (2) post-2017 NOLs carried to that year after applying the 80-percent limitation (see section 172(a)(2)(B)). Additionally, the proposed regulations provide special rules applicable to consolidated groups that include at least one nonlife insurance company, as well as rules applicable to losses arising in a separate return limitation year (SRLY).

2. Application of the 80-Percent Limitation to Groups Comprised of Nonlife Insurance Companies, Members Other Than Nonlife Insurance Companies, or Both

Application of the 80-percent limitation depends on the status of the entity whose income is being offset, rather than on the status of the entity whose loss is being absorbed. As noted in part I.B of the Background, section 172(f) provides that the 80-percent limitation does not apply when the taxable income of a nonlife insurance company is offset by an NOL carryback or carryover.

To implement the special rules under section 172 regarding income of nonlife insurance companies, these proposed regulations clarify that application of the 80-percent limitation within a consolidated group to post-2017 NOLs (post-2017 CNOL deduction limit) depends on the status of the entity that generated the income being offset in a consolidated return year beginning after December 31, 2020. Therefore, if a group is comprised solely of members other than nonlife insurance companies during a consolidated return year beginning after December 31, 2020, the post-2017 CNOL deduction limit for the group for that year is determined by applying the 80-percent limitation to all of the group's consolidated taxable income for that year. In contrast, if a group is comprised solely of nonlife insurance companies during a consolidated return year beginning after December 31, 2020, the post-2017 CNOL deduction limit for the group for that year simply equals the group's CTI less the aggregate amount of pre-2018 NOLs carried to that year.

A two-factor computation is required if a consolidated group is comprised of both nonlife insurance companies and other members in a consolidated return year beginning after December 31, 2020. In general, under these proposed regulations, the post-2017 CNOL deduction limit for the group would equal the sum of two amounts.

The first amount relates to the income of those members that are not nonlife insurance companies (residual income pool). This amount equals the lesser of (i) the aggregate amount of post-2017 NOLs carried to that year, or (ii) 80 percent of the excess of the group's CTI for that year (determined without regard to income, gain, deduction, or loss of members that are nonlife insurance companies and without regard to any deductions under sections 172, 199A, and 250) over the aggregate amount of pre-2018 NOLs carried to that year that are allocated to the positive net income of members other than nonlife insurance companies.

The second amount relates to the income of those members that are nonlife insurance companies (nonlife income pool). This amount equals 100 percent of the group's CTI for the year (determined without regard to any income, gain, deduction, or loss of members that are not nonlife insurance companies), less the aggregate amount of pre-2018 NOLs carried to that year that are allocated to the positive net income of nonlife insurance company members.

For purposes of computing the foregoing amounts, pre-2018 NOLs are allocated pro rata between the two types of income pools in the group (that is, the income pool for nonlife insurance companies and the income pool for all other members, respectively). This allocation is based on the relative amounts of positive net income in each pool in the particular consolidated return year.

For example, assume that P, PC1, and PC2 are members of a calendar-year consolidated group (P Group). PC1 and PC2 are nonlife insurance companies, and P is a holding company. In 2017, the P Group has a CNOL of $10 (that is, a pre-2018 NOL). In 2021, P has income of $50, PC1 has income of $70, and PC2 has a loss of $20. Therefore, the P Group has $100 of CTI in 2021. In 2022, the P Group has a $100 CNOL (all of which is attributable to PC1 and PC2) that is carried back to 2021. Under sections 172(a)(2)(B) and 172(f), the P Group's 2022 CNOL would offset P's 2021 income subject to the 80-percent limitation, but it would offset PC1's 2021 income without limitation.

The total amount allowed as a CNOL deduction in the P Group's 2021 consolidated return year equals the aggregate amount of pre-2018 NOLs carried to that year plus the P Group's post-2017 CNOL deduction limit for that year. The P Group has $10 of pre-2018 NOLs carried to 2021. Under section 172(a)(2)(A) and Section 1.1502-21(b)(1), this loss would offset $10 of the P Group's 2021 income.

Under these proposed regulations, the P Group's post-2017 CNOL deduction limit for its 2021 consolidated return year is equal to the sum of the following two amounts. The first amount reflects the application of the 80-percent limitation to P's income (that is, the residual income pool). This amount is $36, which equals the lesser of (i) the aggregate amount of the P Group's post-2017 NOLs carried to its 2021 consolidated return year ($100), or (ii) the product obtained by multiplying 80 percent by $45 (the excess of $50 (P's 2021 income) over $5 (the pro rata amount of pre-2018 NOLs allocated to P's income)).

The second amount reflects the application of section 172(f) to the income of PC1 and PC2 (that is, the nonlife income pool). This amount is $45, which is obtained by subtracting $5 (the pro rata amount of pre-2018 NOLs allocated to the income of PC1 and PC2) from $50 (PC1's 2021 income of $70-PC2's 2021 loss of $20).

Thus, the P Group has a CNOL deduction of $91 for 2021, which includes (1) the aggregate amount of pre-2018 NOLs carried to 2021 ($10), plus (2) the P Group's post-2017 deduction limit ($36 + $45 = $81). The P Group has $9 of CTI in 2021 and carries over the remaining $19 of its 2022 CNOL ($100-$81) to future taxable years.

If a group's nonlife insurance company members have net income for a particular consolidated return year beginning after December 31, 2020, and its other members have a net loss for that year (or vice-versa), these proposed regulations modify the foregoing computation to ensure that the group's post-2017 CNOL deduction limit for that year is not overstated. If the group's nonlife insurance company members have a loss for the consolidated return year and its other members have income for that year, the group's post-2017 CNOL deduction limit equals the lesser of (i) the aggregate amount of post-2017 CNOLs carried to the year, or (ii) 80 percent of the excess of the group's CTI (determined without regard to any deductions under sections 172, 199A, and 250) over the aggregate amount of pre-2018 NOLs carried to that year. That is, because none of the group's net income has been produced by the group's P&C insurance operations, the 80-percent limitation will apply to all CTI for the year. Conversely, if the group's nonlife insurance company members have income for the consolidated return year and its other members have a loss for that year, the group's post-2017 CNOL deduction limit equals the group's CTI less the aggregate amount of pre-2018 NOLs carried to that year. That is, because all net income of the group has been produced by the operation of members that are nonlife insurance companies (whose income is not subject to the 80-percent limitation), all CTI for the year may be offset by post-2017 CNOL deductions.

In formulating these proposed regulations, the Treasury Department and the IRS considered an alternative approach. Following the enactment of the TCJA and the CARES Act, section 172 provides special rules applicable to entities of different tax status, both with regard to the use of NOLs to offset income and with regard to the manner in which NOLs are carried over. This alternative approach 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 for all purposes of section 172 applicable to taxable years beginning after December 31, 2020. In other words, the alternative approach would have applied a pooling concept beyond merely determining the group's post-2017 CNOL deduction limit, but would have required a group's CTI to be allocated between the operations of its nonlife insurance company members, which can be offset fully by CNOL deductions, and the operations of its other members subject to the 80-percent limitation. This alternative approach would also have applied similar rules to allocate CNOLs within groups including both nonlife insurance companies and other members to consistently identify the portions of CNOLs allocable to nonlife insurance company members, which are subject to different carryover rules than those of other members.

Specifically, this alternative approach would have adopted a threshold computational step under which the principles of 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. The remaining members of the group would be subject to a parallel offset. Following this initial offsetting of pooled items, Section 1.1502-21(b)(2)(iv)(B) (or the principles of Section 1.1502-21(b)(2)(iv)(B), in the case of a group with CTI) would apply to allocate a post-2017 CNOL among all group members with taxable income. This approach contrasts with the historical application of Section 1.1502-21(b)(2)(iv)(B), under which a CNOL for a year is attributed pro rata to all members of a group that produce net loss, without first netting among entities of the same type. This historical approach developed before the enactment of the TCJA, and thus before special carryover rules applied to nonlife insurance companies.

The Treasury Department and the IRS request comments regarding the proposed regulations' methodology for computing a group's post-2017 CNOL deduction limit. The Treasury Department and the IRS also request comments regarding the alternative approach described in the preceding two paragraphs to identify the portion of the CNOL to which the special carryback and carryover rules of section 172(b) (regarding nonlife insurance company losses) would apply.

3. Losses Arising in a SRLY

Generally, an unaffiliated corporation determines its taxable income by offsetting its NOLs against its income. In contrast, a consolidated group member generally offsets its NOLs against the income of all group members. See Sections 1.1502-11 and 1.1502-21. However, an exception to this general rule for consolidated groups applies to a group's use of NOLs incurred by a member (SRLY member) in a taxable year other than a year of the current group (that is, a separate return limitation year or SRLY). A SRLY member may carry its NOLs that arose in a SRLY into the consolidated group, but those NOLs can be absorbed by the group only to the extent that the SRLY member generates income on a separate-entity basis while a member of the group (that is, to the extent of the amount of net income generated by the SRLY member as a member of the group). See generally Section 1.1502-21(c)(1)(i) (setting forth the general SRLY limitation rule).

The SRLY rules attempt to replicate, to the extent possible, separate-entity usage of the SRLY attributes of the SRLY member. In other words, the SRLY regulations were designed to obtain an absorption result that varies as little as possible from the absorption that would have occurred if the SRLY member had not joined the consolidated group.

To approximate a SRLY member's absorption of NOLs on a separate-entity basis, the SRLY member's net contribution to the CTI of the group is measured cumulatively over the period during which the corporation is a member of the group by using what is commonly referred to as a "cumulative register." The cumulative register tracks the SRLY member's net positive (or negative) contribution to the income of the group. See Section 1.1502-21(c)(1)(i). If the SRLY member has net positive income in a consolidated taxable year, the member's cumulative register increases. See Section 1.1502-21(c)(1)(i)(A) and (C). In turn, if the losses of a SRLY member (including SRLY-limited NOL carryovers) are absorbed by the group, the SRLY member's cumulative register decreases. See Section 1.1502-21(c)(1)(i)(B) and (C).

These proposed regulations would modify the cumulative register rules to reflect the application of the 80-percent limitation under section 172(a)(2)(B). Under the proposed regulations, as in current Section 1.1502-21, the full amount of the SRLY member's current-year income (or current-year absorbed loss) increases (or decreases) the member's cumulative register. However, when the cumulative register is reduced to account for the group's absorption of any SRLY member's NOLs that are subject to the 80-percent limitation (whether or not those losses are subject to the SRLY limitation), the amount of the reduction equals the full amount of income that would be necessary to support the deduction by the SRLY member.

For example, after absorption of any pre-2018 NOLs of a SRLY member, the SRLY member (other than a nonlife insurance company) would need to have $100 of remaining income to enable the group to absorb $80 of the SRLY member's SRLY-limited post-2017 NOLs in a taxable year beginning after December 31, 2020 (that is, 80 percent of the excess of $100 over $0). Therefore, upon the group's deduction of $80 of NOL (SRLY or otherwise) of the SRLY member, the cumulative register would be reduced to reflect the full $100 of income, not just the $80 of losses absorbed by the group.

The Treasury Department and the IRS have determined that, without the adjustment described, the SRLY member would achieve a different result as a member of a group than as a stand-alone entity. Such result would be contrary to the objective of the SRLY rules, which attempt to replicate the hypothetical separate-entity treatment of the SRLY member. Therefore, the above-described adjustment would be necessary to ensure that the SRLY member achieves the same Federal income tax result as if the SRLY member continued to be a stand-alone entity.

For example, assume that P owns 79 percent of S, and that neither P nor S is a nonlife insurance company. In Year 1 (a taxable year beginning after December 31, 2020), S incurs an $800 NOL that it carries over into Year 2. S has no other NOL carryovers or carrybacks. In Year 2, S has $400 of income; accordingly, S's 80-percent limitation for Year 2 is $320 (that is, the lesser of $800 or 80 percent of the excess of $400 over $0). As a result, S may use $320 of its $800 Year 1 NOL to offset $320 of its $400 Year 2 income. Under section 172(b)(2), the amount of the $800 Year 1 NOL that is carried into Year 3 is the excess of the entire $800 NOL over $320, or $480. S's ability to use any portion of its remaining Year 1 NOL in Year 3 is dependent on its generation of additional taxable income in Year 3.

Now assume that, instead of S filing a separate return for Year 2, P acquires the remaining stock of S at the end of Year 1, and P and S file a consolidated return for Year 2. The P group has $1,000 of income in Year 2, of which S has $400. Thus, S's cumulative register increases from $0 to $400. Because S's $800 Year 1 NOL arose in a SRLY, the absorption of this NOL in Year 2 is subject to both the SRLY limitation and the 80-percent limitation. Under the proposed regulations, the P group may use only $320 (that is, the lesser of $800 or 80 percent of the excess of $400 over $0) of S's Year 1 SRLY NOL to offset the P group's Year 2 income. Upon the absorption of $320 of S's Year 1 SRLY NOL, S's cumulative register is reduced by $400 (that is, the full amount of income necessary to support the $320 deduction of S's Year 1 SRLY NOL) to $0. The remainder of S's Year 1 SRLY NOL is carried over.

If S's cumulative register were not reduced by the full amount of income necessary to support the deduction, the P group's ability to use S's loss would exceed S's ability to use the loss if S had not joined the P group. As an illustration, assume further that, in Year 3, the P group has $200 of income, with no net amount of income or loss attributable to S. Because S's cumulative register would remain at $0, the P group would not be able to offset any of its $200 Year 3 income with S's Year 1 SRLY NOL. If S's cumulative register were reduced solely by the amount of the SRLY NOL deducted in Year 2 ($320), S would have $80 remaining in its cumulative register ($400-$320), and the P group could absorb an additional $64 (that is, the lesser of $480 or 80 percent of the excess of $80 over $0) of S's remaining Year 1 SRLY NOL in Year 3. In contrast, if S had not joined the P group and had not generated any income in Year 3, it would not have been able to use any of its $480 remaining Year 1 SRLY NOL in Year 3. In other words, S would have been able to use a total of only $320 of its Year 1 SRLY NOL in Years 2 and 3.

Therefore, absent an adjustment to S's cumulative register to account for the 80-percent limitation, S would achieve a different result as a member of a consolidated group than if S had remained a stand-alone entity. As explained earlier in this part II.B.3 of this Explanation of Provisions, such a result would be inconsistent with the purpose of the SRLY regime. See the preamble to TD 8823 published in the Federal Register July 2, 1999 (64 FR 36092).

C. Recomputation of Amount of CNOL Attributable to Each Member

Section 1.1502-21(b)(2)(i) generally provides that, if a group has a CNOL that is carried to another taxable year, the CNOL is apportioned among the group's members. For this purpose, Section 1.1502-21(b)(2)(iv) provides a fraction, the numerator of which is the separate NOL of each member for the consolidated return year of the loss (determined by taking into account only the member's items of income, gain, deduction, and loss), and the denominator of which is the sum of the separate NOLs of all members for that year.

If a member's portion of a CNOL is absorbed or reduced on a non-pro rata basis, the percentage of the CNOL attributable to each member must be recomputed to reflect the proper allocation of the remaining CNOL. For instance, if a portion of a CNOL allocable to a nonlife insurance company is carried back to and absorbed in a prior taxable year under the special rule for nonlife insurance companies that applies for taxable years beginning after December 31, 2020 (see part I.B of the Background), all or some portion of the CNOL allocable to the nonlife insurance company is reduced even though the portion of the CNOL allocable to other members remains untouched. Therefore, the allocation of the remaining CNOL must be recomputed.

Accordingly, these proposed regulations provide that, if a member's portion of a CNOL is absorbed or reduced on a non-pro rata basis, the percentage of the CNOL attributable to each member is recomputed. The recomputed percentage of the CNOL attributable to each member equals the remaining CNOL attributable to the member at the time of the recomputation, divided by the sum of the remaining CNOL attributable to all of the remaining members at the time of the recomputation. In other words, if at the time of the recomputation a member's attributable portion of the group's remaining CNOL equals $20, and the sum of the remaining CNOL attributable to all of the group's remaining members equals $80, the recomputed percentage of the CNOL attributable to the member would equal 25 percent.

Proposed regulations (REG-101652-10) published in the Federal Register (80 FR 33211) on June 11, 2015 (2015 proposed regulations) contained a similar rule (see Section 1.1502-21(b)(2)(iv)(B)(2) of the 2015 proposed regulations). These proposed regulations withdraw proposed Section 1.1502-21(b)(2)(iv)(B)(2) of the 2015 proposed regulations and re-propose substantially similar language in new proposed Section 1.1502-21(b)(2)(iv)(B)(2).

D. Farming Losses

For a taxable year beginning after December 31, 2020, section 172(b)(1)(B) permits the portion of a taxpayer's NOL for the taxable year that is a farming loss to be carried back two years. Under that provision, the term "farming loss" means the lesser of the amount that would be the NOL if only the income and deductions attributable to farming businesses (as defined in section 263A(e)(4)) were taken into account, or the amount of a taxpayer's NOL for the year.

Whereas the special nonlife insurance company rules in section 172 apply based on the status of the entity that generated the loss, the special farming loss carryback rules in section 172 apply based on the character of the loss; that is, whether the loss resulted from farming activity. The special rule for farming losses creates a situation similar to that addressed in United Dominion Industries, Inc. v. United States, 532 U.S. 822 (2001), which involved the calculation within a consolidated group of a product liability loss (PLL). A PLL was a "special status loss" that was subject to a 10-year carryback period and that was equal to the aggregate of all members' product liability expenses (PLEs), limited by the NOL for the year. A consolidated group generally is treated as having a single, unitary CNOL for a taxable year (based on all items of income and loss in the group) that is allocated among members only for specified purposes, including carrybacks and carryovers to other taxable years. See Section 1.1502-21(e) (defining the term "CNOL"); Section 1.1502-11(a) (setting forth the general computation for determining CTI). Because the regulations under section 1502 did not allocate the CNOL for purposes of calculating the limitation on PLL, the Supreme Court held that the amount of a group's PLL was limited by the entire amount of the group's CNOL.

In a notice of proposed rulemaking (REG-140668-07) published in the Federal Register (77 FR 57452) on September 17, 2012 (2012 proposed regulations), the Treasury Department and the IRS provided rules regarding the apportionment of CNOLs that contain a component portion of a special status loss, such as a corporate equity reduction interest loss or a specified liability loss. Such losses, like farming losses and the PLLs that were considered in United Dominion, were subject to special carryback rules. The 2012 proposed regulations effectuated the holding in United Dominion that a group's CNOL, which is the limit on the amount of a group's special status losses, may be generated anywhere in the group. See 77 FR 57452, 57458. On that basis, the 2012 proposed regulations apportioned such special status losses to each group member that generated a loss in the year in which the special status loss was incurred, regardless of whether any specific member had undertaken the activities that generated the expenses that effectively were granted special status. See id.

Consistent with the 2012 proposed regulations, these proposed regulations re-propose, in modified form, a specific rule regarding the apportionment of CNOLs that include farming losses arising in taxable years beginning after December 31, 2020, or other special status losses. See proposed Section 1.1502-21(b)(2)(iv)(D). (Due to the TCJA's removal of the corporate equity reduction interest loss provisions in former section 172(g), proposed Section 1.1502-21(b)(2)(iv)(D) does not contain explicit rules governing such losses.) Under proposed Section 1.1502-21(b)(2)(iv)(D), the portion of the CNOL constituting a special status loss is apportioned to each group member separately from the remainder of the CNOL under the method provided in Section 1.1502-21(b)(2)(iv). Consistent with the 2012 proposed regulations, this apportionment occurs without separate inquiry into whether a particular member actually incurred the special status loss. See 77 FR 57452, 57458. These proposed regulations withdraw Section 1.1502-21(b)(2)(iv)(C), as proposed in the 2012 proposed regulations. The Treasury Department and the IRS request comments regarding this approach.

E. Elections To Waive Portions of the Five-Year Carryback Period Under Section 172(b)(1)(D)(i)

Temporary regulations in the Rules and Regulations section of this issue of the Federal Register add new paragraphs (b)(3)(ii)(C) and (D) to the regulations in Section 1.1502-21. The temporary regulations provide rules to permit consolidated groups that acquire new members that were members of another consolidated group to elect to waive all or part of the pre-acquisition portion of an extended carryback period under section 172 for certain losses attributable to the acquired members. The text of those regulations also serves as the text of Section 1.1502-21(b)(3)(ii)(C) and (D) of these proposed regulations. The preamble to the temporary regulations explains the amendments.

III. Amendments to Section 1.1502-47

A. Overview

1. Legislative Background at the Time the Current Life-Nonlife Regulations Were Promulgated

The Life Insurance Company Income Tax Act of 1959, Public Law 86-69, 73 Stat. 112 (June 25, 1959), established a three-phase system of taxation for life insurance companies (also referred to as life companies). Under the first phase of this three-phase system (phase 1), a life company was taxed on the lesser of its taxable investment income (TII) or its gain from operations (GO). If a company's GO exceeded its TII, the company was taxed on 50 percent of such excess (phase 2). The other half of the GO in excess of TII was added, along with certain other items, to the policyholders surplus account, which was taxed when distributed to shareholders of a stock company (phase 3). Life companies also were permitted certain deductions that were unique to insurance companies, such as increases in reserves to the extent not funded out of the policyholders' share of investment income.

Prior to the enactment of the Tax Reform Act of 1976, Public Law 94-455, 90 Stat. 1520 (October 4, 1976) (1976 Act), life companies were prohibited from filing consolidated returns with nonlife companies, including both nonlife insurance companies and other types of corporations. This prohibition resulted in part from historical differences between the taxation of life companies and nonlife companies.

Section 1507 of the 1976 Act (90 Stat. 1520, 1739-41) permitted life companies to consolidate with nonlife companies, subject to additional restrictions that do not apply to a regular consolidated group. Section 1503(c)(1) (as amended by the 1976 Act and subsequent tax legislation) provides that, if the nonlife company members of a life-nonlife group (nonlife members) have a loss for the taxable year, then under regulations to be issued by the Secretary, the amount of the loss that cannot be carried back and absorbed by the taxable income of the nonlife members can be taken into account in determining the CTI of the group only to the extent of the lesser of 35 percent of such loss or 35 percent of the taxable income of the life company members of the group (life members). Further, section 1503(c)(2) (as so amended) provides that the losses of a recent nonlife affiliate may not be used by a life company before the sixth taxable year the companies have been members of the same affiliated group.

2. Current Life-Nonlife Regulations

The current life-nonlife regulations adopted a subgroup method for computing a life-nonlife group's CTI. Under the subgroup method, the nonlife members and the life members generally are treated as if the members compose two separate consolidated groups, with certain exceptions (including intercompany transactions, as defined in Section 1.1502-13(b)(1)(i)). Thus, each of the life subgroup and the nonlife subgroup separately calculates its taxable income. Subgroup losses that are eligible to be carried back must be carried back to offset subgroup income in prior taxable years before being used to offset income of the other subgroup in the current taxable year, and subgroup losses may not be carried back to offset income of the other subgroup in prior taxable years.

Further, a carryback of a subgroup loss may "bump" the loss of the other subgroup used in the carryback year (that is, the loss that is carried back may supplant a loss of the other subgroup in the carryback year). See Section 1.1502-47(a)(2)(ii). For example, assume that life subgroup losses were used to offset nonlife subgroup income in Year 1. If the nonlife subgroup incurs losses in Year 2 that are eligible to be carried back to Year 1, those Year 2 nonlife subgroup losses (rather than the Year 1 life subgroup losses) would be used to offset the nonlife subgroup's income in Year 1. The "bumped" life subgroup losses from Year 1 then would be carried over to future taxable years.

3. Legislative Changes Regarding the Taxation of Insurance Companies Since Promulgation of the Current Life-Nonlife Regulations

The Deficit Reduction Act of 1984, Public Law 98-369, 98 Stat. 494 (July 18, 1984) (1984 Act), significantly altered the taxation of life companies. The 1984 Act replaced the three-phase system with a statutory mechanism similar to that used to calculate the Federal income tax liability of other corporate taxpayers. Specifically, section 801(a) imposes an income tax on the life insurance company taxable income (LICTI) of a life company, and section 801(b) defines "life insurance company taxable income" as life insurance gross income less life insurance deductions. The legislative history of the 1984 Act indicates that, in part, Congress changed the taxation of life companies in order to simplify the Code. See Staff of the Joint Comm. on Tax'n, 98th Cong., General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 577 (December 31, 1984).

In turn, the Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 2085 (October 22, 1986) (1986 Act), modified the taxation of nonlife insurance companies. Prior to the 1986 Act, nonlife insurance companies were permitted to defer unearned premium income while currently deducting the expenses associated with earning such income, which created a timing mismatch between the income and expenses of nonlife insurance companies. The 1986 Act addressed this mismatch by requiring a nonlife insurance company to reduce its deduction for unearned premium income by 20 percent. The 1986 Act also repealed special rates, deductions, and exemptions for small mutual insurance companies and added a single provision (section 831(b)) for both small mutual insurance companies and small stock insurance companies.

Lastly, the TCJA made significant additional changes to the taxation of life insurance companies, and the CARES Act added a special rule for such companies in section 172(b)(1)(D)(iii). These changes are described in detail in part II of the Background.

B. Summary of Proposed Changes to Section 1.1502-47

As a result of changes in the taxation of insurance companies under the TCJA and prior legislation, various provisions in Section 1.1502-47 currently are outdated. Accordingly, to the extent preempted by statute, the current regulations have no application. These proposed regulations update Section 1.1502-47 by: (1) Removing paragraphs implementing statutory provisions that have been repealed; (2) revising paragraphs implementing statutory provisions that have been substantially revised; (3) updating terminology and statutory references to account for other statutory changes; and (4) removing paragraphs that contain obsolete transition rules or that are no longer applicable because the effective dates in the current life-nonlife regulations have passed.

1. Removal of Paragraphs Due to Repealed Statutory Provisions

Certain paragraphs in Section 1.1502-47 are no longer relevant to the calculation of life-nonlife CTI because of the repeal of the three-phase system by the 1984 Act and later amendments to the Code. Therefore, these proposed regulations remove numerous paragraphs including current Sections 1.1502-47(k) and (l), which provide rules for calculating consolidated TII and the consolidated GO or loss from operations (LO). These proposed regulations also remove (i) Section 1.1502-47(f)(7)(ii), which generally provides that the consolidated tax liability of a life-nonlife group includes the tax described by section 1201, and (ii) Section 1.1502-47(o), which provides rules for calculating the alternative tax imposed by section 1201 on consolidated capital gain. (As noted in part II of the Background, section 1201 was repealed by the TCJA.)

2. Updates Reflecting Substantially Revised Statutory Provisions

These proposed regulations also update Section 1.1502-47 to reflect changes to certain statutory provisions since the current life-nonlife regulations were promulgated. For example, these proposed regulations modify current Section 1.1502-47(f)(5) (relating to the dividends received deduction) to reflect changes by the 1986 Act to sections 805(a)(4) and 818(e)(2) (for life companies) and to reflect changes by the 1986 Act and the Technical and Miscellaneous Revenue Act of 1988, Public Law 100-647, 102 Stat. 3342 (November 10, 1988), respectively, to sections 832(b)(5)(B) and (g) (for nonlife insurance companies). Under modified Section 1.1502-47(f)(5) (that is, proposed Section 1.1502-47(d)(5)), dividends received by an insurance company from another includible member of the group are treated as if the group were not filing a consolidated return. To reflect the repeal of section 815 by the TCJA, these proposed regulations also remove current Section 1.1502-47(g)(3) (which provides that life-nonlife groups must include any amounts subtracted under section 815 from life members' policyholders surplus accounts).

Additionally, these proposed regulations update the rules relating to consolidated LICTI to reflect the repeal of the three-phase system by the 1984 Act and other changes to the taxation of life companies. These proposed regulations also move certain provisions in current Section 1.1502-47(k) (consolidated TII) and (l) (consolidated GO or LO) that remain applicable following the repeal of the three-phase system to revised paragraph (g), and they implement the special rule for life insurance companies in section 172(b)(1)(D)(iii) under the CARES Act.

3. Revisions to Account for Other Statutory Changes

These proposed regulations also update terminology and citations to the Code to reflect current law. For example, these proposed regulations remove references to section 821 and mutual insurance companies because the statutory provisions regarding mutual insurance companies were repealed by the 1986 Act. Additionally, these proposed regulations replace references to section 802 with references to section 801 because section 802 was repealed by the 1984 Act. Similarly, these proposed regulations replace references to the LO with references to the NOL deduction under section 172 to reflect the repeal of section 810 by the TCJA.

4. Removal of Obsolete Transition Rules and Other Rules That No Longer Are Applicable

These proposed regulations propose the removal of transition rules regarding the implementation of the current life-nonlife regulations, since those transition rules apply to carryovers that either have been absorbed or have expired. For example, the proposed regulations propose the removal of current Section 1.1502-47(h)(3) (setting forth transition rules for NOLs attributable to taxable years ending before January 1, 1981), current Section 1.1502-47(k)(6) (containing a similar rule for certain capital loss carryovers), and current Section 1.1502-47(e)(4) (granting certain life-nonlife groups permission to discontinue filing a consolidated return for the group's first taxable year for which the current life-nonlife regulations were effective).

These proposed regulations also would remove cross-references to certain prior-law regulations that are designated with an "A" because those regulations generally are applicable to years ending in 1999 or earlier. Additionally, these proposed regulations would remove cross-references to Section 1.1502-18 (relating to inventory adjustments) because that section does not apply to taxable years beginning after July 11, 1995.

Douglas W. O'Donnell,

Acting Deputy Commissioner for Services and Enforcement.

[FR Doc. 2020-14427 Filed 7-2-20; 4:15 pm]

BILLING CODE 4830-01-P

The document is published in the Federal Register: https://www.federalregister.gov/documents/2020/07/08/2020-14427/consolidated-net-operating-losses

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