CCA Provides Reminder of the interaction between Charitable Contribution Carryovers and NOL Carryovers

October 2019

On July 12, 2019, the IRS released Chief Counsel Advice 201928014 (CCA), which outlines in detail the required ordering when utilizing charitable contribution carryovers in connection with utilizing net operating loss (NOL) carryovers.
 

Background

Corporations are allowed a deduction for charitable contributions subject to a limitation of 10% of taxable income. The excess of current-year contributions over the limitation carries forward for five taxable years. Any unused carryover expires on the first day of the sixth year.

When a corporation’s deductions are in excess of gross income, a net operating loss (NOL) is created. Generally, NOLs created during taxable years beginning before January 1, 2018, are permitted to be carried back two years and forward 20 years. Under the Tax Cuts and Jobs Act, NOLs incurred during taxable years beginning after December 31, 2017, can only be carried forward; however, the carryover period is indefinite.  (This paragraph assumes that a technical correction is ultimately enacted to carry out the intent of Congress.  As enacted, the prohibition on NOL carrybacks applies to taxable years ending after December 31, 2017.)

In subsequent years, when an NOL is used to offset a C corporation’s taxable income, the amount of an NOL that is absorbed in a taxable year equals a taxpayer’s modified taxable income (MTI) – taxable income determined with certain modifications under Section 172(b)(2). If an NOL carried to a taxable year is more than the modified taxable income for the taxable year, the excess of the NOL over the MTI is carried to the next taxable year.

Under Section 172(b)(2), MTI is determined without taking into account the NOL to be absorbed or NOLs incurred in taxable years after the taxable year of the NOL to be absorbed. However, NOLs carried from years before the taxable year of the NOL to be absorbed are considered in determining MTI, as are charitable contribution deductions. If an NOL deduction reduces a taxpayer’s taxable income to $0, no charitable contribution deduction is allowable for that taxable year.

In certain situations, more charitable contributions may be allowable in computing MTI than are allowable in computing taxable income under Section 170(b)(2). By reducing MTI, the charitable contributions result in less NOL being absorbed than the actual amount of NOL used to reduce taxable income. Thus, the amount of the additional charitable contributions allowed in determining MTI increases the amount of NOL carryovers to a subsequent taxable year.

These mechanics in essence convert charitable contribution carryovers to NOL carryovers. The difference in the carryover provisions for NOLs versus charitable contributions makes this a taxpayer-favorable result.

When the NOL carryover is used, the earliest year’s NOL is used first. In contrast, when using charitable contribution deductions, the contributions incurred during the current year are absorbed first, then the earliest year’s carryover is reduced.
 

A Simplified Illustration

The CCA provides a simplified example to illustrate this point. X Corp had $1,000 of taxable income in 2017 before considering its NOL carryovers or charitable contribution deduction. X Corp had NOL carryovers of $5,000 available to use in 2017, which included $100 from 2012 and $1,500 from 2013. There were no NOL carryovers from pre-2012 years. X Corp also had charitable contribution carryovers available to use in 2017 of $300, which included $150 from 2012. In 2017, X Corp made charitable contributions of $120.

In this example, X Corp cannot deduct any charitable contributions in 2017 because the NOL carryovers reduce taxable income for 2017 to $0. But X Corp still must compute the 10% limit for purposes of determining MTI and the amount of the NOL carryovers that are absorbed.

First, X Corp must subtract its 2012 NOL from its 2017 taxable income to determine the Section 170 taxable income ($1,000 - $100 = $900). X Corp must then multiply its Section 170 taxable income by the 10% limitation ($900 x 10% = $90). The $90 represents the amount of the 2017 charitable contribution that is allowed for purposes of calculating MTI (under Section 172(b)(2)). As a result, the 2017 MTI is $810 ($900 - $90).

Second, because X Corp cannot deduct any charitable contributions in 2017 and it has NOL and charitable carryovers, it must determine how much of the 2017 charitable contributions it can carry over to 2018 after applying the Section 170(d)(2)(B) adjustment. X Corp must reduce its 2017 charitable contributions by $90 because that amount was allowed in the MTI calculation ($900 - $90 = $810), resulting in an increased NOL carryover to 2018 and the charitable contributions not actually being deducted. The result is that only $30 ($120 - $90) of the 2017 charitable contributions is allowed to be carried over to 2018.

Lastly, X Corp must calculate the amount of the 2013 NOL carryover that is absorbed under Section 172(b)(2) and the amount carried over to 2018. The 2013 NOL carryover is reduced by the amount absorbed (the 2017 MTI, or $810), and the remainder is carried over to 2018 ($1,500 - $810 = $690).

In this example, only the current year charitable contributions are considered in calculating the Section170(d)(2)(B) adjustment because the current year charitable contributions alone reduced MTI in the absorption calculation of Section 172(b)(2) and increased the NOL carryover to a succeeding year under Section 172. Accordingly, X Corp loses the ability to use any charitable contribution carryovers from 2012 as a result of the expiration of the five-year carryover period.
 

Conclusion

Taxpayers should closely review their corporate tax returns to ensure that the appropriate amount of charitable contribution deduction converts to an NOL when taxable income is reduced by an NOL carryover deduction in concert with charitable contributions.
 

CONTACT
 
Randy Schwartzman
Tax Partner and Practice Leader
 
  Doug Bekker
Tax Partner
 

 
Kevin Anderson
Tax Managing Director
 
  Kevin Ainsworth
Tax Managing Director
 

 
Eric Mauner
Tax Senior Manager
 
  Heath Wang
Tax Manager