Navigating M&A Tax Strategy: A Focus on Net Operating Losses (NOLs)

Maher Abduselam, Esq., CPA

October 10, 2023

Understanding NOLs and Their Tax Treatment

In the realm of corporate taxation, Net Operating Losses (NOLs) stand out as a crucial element. NOLs occur when a company's tax-deductible expenses surpass its taxable revenues. These losses hold significant value in mergers and acquisitions(M&A), as they can be used to offset taxable income, thus reducing a corporation's tax burden.

Carryforwards and Carrybacks Explained

Historically, NOLs offered flexibility in tax planning. Before the Tax Cuts and Jobs Act (TCJA), corporations could carry NOLs back two years and forward twenty years, allowing them to offset 100% of taxable income. This meant they could amend past tax returns to claim refunds or reduce future taxable income.

Strategies for Maximizing NOL Benefits

In M&A transactions, NOLs can be strategically used to enhance deal value. Before the TCJA, a common approach was to structure a transaction to utilize a target corporation's NOLs, either through an actual or deemed asset sale. This could reduce the tax cost of the sale and offer the buyer a stepped-up basis in the assets.

Another strategy involved carrying back NOLs to claim refunds of previously paid taxes, an approach particularly beneficial if significant transaction-related deductions, like investment banker fees or legal fees, were involved.

Recent Tax Law Changes Affecting NOLs

The TCJA and CARES Act introduced significant changes to NOL treatment. The TCJA placed an 80%limitation on the deductibility of NOLs arising after December 31, 2017, and eliminated carrybacks while allowing indefinite carryforwards. The CARES Act later adjusted these rules for NOLs from 2018 to 2020, permitting a five-year carryback and removing the 80% limitation for years before 2021.

Navigating NOLs with Professional Assistance

Navigating the complexities surrounding NOLs requires nuanced understanding and strategic planning, especially in light of recent tax law changes. Corporations must be mindful of provisions like Section 382, which limits NOL usage after ownership changes, and Section 269, which scrutinizes transactions motivated primarily by tax avoidance.

In light of these complexities, it's advisable for corporations engaged in M&A activities to seek professional guidance. This ensures not only compliance with tax laws but also the optimization of available tax benefits.