David Rosenbloom and Clark Armitage Comment on New Restrictions on Tax Carryovers

The international provisions of the 2017 tax overhaul often limit the ability of taxpayers to carry forward losses or credits and smooth over their tax liabilities, leveling an unexpected tax hit on companies with uneven years of profitability.

Practitioners are warning companies in cyclical industries, such as insurance, to prepare for years when they can’t rely as much on net operating losses and foreign tax credits from prior years as they might have expected. The effect is especially pronounced with the Tax Cuts and Jobs Act’s provisions on global intangible low-taxed income and foreign-derived intangible income. Both arrive at lower rates through steep deductions — which can only be used the year they are granted.

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“The problem is not resolvable by regulations,” said David Rosenbloom, a member of Caplin & Drysdale in Washington. “It couldn’t be clearer.”

The Department of the Treasury did not address the apparent disparity in its proposed regulations on Section 250 , which outlines the GILTI and FDII deductions.

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The issue could be seen as one of many seemingly arbitrary decisions tax writers were forced to make in determining how to construct a complex law.

“This isn’t really a deduction; what it is a rate reduction, masquerading as a deduction,” said Rosenbloom, who also noted that many other deductions include limits on their ability to be carried forward.

Clark Armitage, also at Caplin & Drysdale in Washington, noted that the law also favors some companies in a loss position in some situations. Foreign-derived intangible income is calculated as returns of 10 percent above qualified business asset investment, or most types of depreciable assets.

If income isn’t FDII, it’s taxed at the full 21 percent rate — so companies have a reason to want as much reported income as possible. Losses, carried forward, would actually hurt a company’s bottom line by classifying more income as normal income, and not FDII.

The effect is reversed for GILTI, as it would otherwise be foreign income exempt from U.S. taxation entirely. In addition, controlled foreign corporations with a loss are excluded from the calculation for GILTI entirely.

“One of the things that tax advisers are telling their clients is, don’t have a loss CFC,” Armitage said. “Change its risk profile to have it more of a limited risk operation with predictable profits, get your transfer pricing right, so it always has some tested income.”

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Excerpt taken from the article “TCJA Could Trip Up Companies With Loss Years” by Alex M. Parker for Law360.