NBC Letter re: Net Operating Loss (NOL) Deductions in Tax Cuts & Jobs Act of 201

Dear Chairman Hatch & Chairman Brady:

The National Bankruptcy Conference (“NBC”) is a voluntary, non­ partisan, not-for-profit organization composed of about 60 of the nation’s leading bankruptcy judges, professors and practitioners. It was organized at the request of Congress and has provided advice to Congress on bankruptcy legislation for nearly 80 years. We enclose a Fact Sheet, which provides further information about the NBC.

We write on behalf of the NBC to urge Congress to reject certain proposals (the “Proposals”) regarding net operating loss (“NOL”) deductions in both the House of Representatives and Senate versions of the Tax Cuts and Jobs Act of 2017 (the “Jobs Act”). While the Proposals do not amend or revise the bankruptcy laws, the NOL provisions in the Internal Revenue Code play a significant role in the restructuring of troubled companies both in and out of the U.S. bankruptcy courts, giving the NBC a keen interest in the policy implications of the Proposals. In particular, the NBC believes that the Proposals will have a potentially adverse impact on employment levels and economic growth in the United States, and we urge you to consider this adverse impact as you continue legislative debate of the Jobs Act.

In general, an NOL is the amount by which a taxpayer’s allowable current-year deductions exceed its current-year gross income. The ability to “carryback” or “carryforward” NOLs from a given taxable year to offset income from previous tax years, or to offset income in future tax years, has for nearly 100 years been a staple of the U.S. tax system, beginning with the Internal Revenue Act of 1918. As the Supreme Court explained, the policy aim of NOL carryback and carryforward provisions is to avoid punishing taxpayers for the admitted arbitrariness of the annual accounting periods for taxes:

[The NOL carryback and carryforward] provisions were enacted to ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They were designed to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year.¹

The NOL carryback in particular promotes equitable treatment of similarly situated parties who differ only with respect to the timing of their items of income and loss. Previous Congresses have periodically limited the ability to carryback NOLs, only to later reenact or expand NOL carrybacks, usually during periods of economic contraction, as the value of such refunds to distressed companies and the broader national economy becomes apparent. This “on-again, off-again” approach to NOL carrybacks is inherently dangerous, because Congress invariably can act only after the damage to the economy from having limited the carryback has already occurred. As explained below, we clearly saw that phenomenon in 2009, when Congress acted to expand the NOL carryback to five years, but not in time to save scores of companies and thousands of jobs.

Under current law (Section 172(b) of the Internal Revenue Code of 1986 (the “Code”)), a taxpayer generally may carryback an NOL up to two years and carryforward an NOL up to twenty years from the year in which the NOL arose. Unless a taxpayer waives carrying back an NOL, the deduction will first be applied to the two years preceding the loss—starting with the earliest of the two years—and then applied prospectively for up to twenty years.

Section 3302 of the Jobs Act would amend Section 172(b)(1) of the Code to disallow carrying back NOLs, except for a very limited one-year carryback for eligible casualty and disaster losses. The House bill also provides that NOLs may be carried forward to successive tax years indefinitely and would be increased by multiplying the amount of the loss carried over by the sum of the annual Federal short-term rate for the last month ending before the beginning of such taxable year plus four percentage points. The Senate version of the Jobs Act likewise contemplates repealing the carryback of NOLs and allowing indefinite carryforward.²

Our Conferees are generally of the view that eliminating NOL carrybacks would seriously impair the ability of financially troubled companies to restructure, jeopardizing ongoing operations and employment. This result would undercut one of the central goals of the Jobs Act: stimulating job growth and creating sustainable economic growth. NOL carrybacks allow distressed firms to receive tax refunds from prior tax years, providing much needed capital to troubled companies, allowing them to preserve jobs and smoothing the shocks of the business cycle.

Eliminating any NOL carryback in the name of fiscal responsibility would be a false economy. As explained below, previous experiments with repealing or limiting NOL carrybacks have illustrated that the modest savings from such policies do not justify the costs they impose in the form of disrupting employment and threatening the viability of economically sound businesses. History of the NOL Carryback - Revenue Act of 1918 & Post-World War I Contractions³ The Revenue Act of 1918 introduced the original NOL deduction as a relief measure anticipating a decrease in economic growth following the First World War.⁴ Congress expected that the manufacturing sector in particular would incur losses as wartime demand waned and factories were repurposed for the post-war economy. Indeed, the U.S. economy entered a recession from August 1918 through March 1919 and then entered a more severe downturn from January 1920 through July 1921.⁵ The NOL deduction introduced in 1918 provided relief to troubled companies during these periods of contraction by allowing NOLs to be carried forward and backward one year.

In 1921, Congress reauthorized the NOL carryforward, but did not provide for NOL carrybacks.⁶ It would take two decades and the economic implications of another world war for Congress to reenact the NOL carryback. Revenue Act of 1942 & the Post-World War II NOL Carryback During the Second World War, certain industries, such as the tourism and hospitality industry, expected substantial losses. To enable such businesses to deduct wartime losses against pre-war income, Congress reintroduced an NOL carryback provision, allowing a two-year carryback period.⁷

The Revenue Act of 1950 shortened the NOL carryback-period to one year, while extending the NOL carryforward-period to five years.⁸ In 1954, Congress overhauled the Internal Revenue Code by enacting the Internal Revenue Code of 1954. This new code extended the carryback-period to two years. Concerns about the economy once again motivated this extension. Specifically, the extension coincided with the tapering of an inflationary period during the Korean War. Decreases in economic demand and the Federal Reserve’s tightened monetary policy precipitated a recession in 1953. The extended NOL carryback helped ameliorate the impact of losses during this downturn. Another recession later in the decade (1957-58) prompted Congress to lengthen the carryback period again, this time extending it to three years.⁹ The general carryback period remained static throughout the rest of the century until Congress shortened it in the late 1990s. NOL Carrybacks in the 21st Century The Taxpayer Relief Act of 1997 reduced the carryback period from three to two years. According to the legislative history:

Congress believed that allowing a two-year carryback of NOLs is sufficient to account [for business cycles that exceed twelve months], particularly since (1) many deductions allowed for tax purposes relate to future, rather than past, income streams and (2) certain deductions that do relate to past income streams are granted special, longer carryback periods under present law . .. .¹⁰

Shortly thereafter, however, Congress extended the general carryback period for taxable years ending in 2001 and 2002 to five years to mitigate the adverse economic effects of the Dot-Com Crash and the September 11 attacks.¹¹

In 2009, the Great Recession prompted Congress to again expand the duration and scope of the NOL carryback period. The American Recovery and Reinvestment Act (“ARRA”) initially allowed an electing small business to carryback NOLs from tax year 2008 for a period of three, four, or five years.¹² Congress then expanded this longer carryback period in November 2009 to other taxpayers (excluding taxpayers receiving assistance under the Troubled Asset Relief Program).¹³ However, this expansion of the NOL carryback occurred after the bankruptcies of such institutions as General Motors, Chrysler, Charter Communications, the Tribune Company, Lyondell Chemical, and General Growth Properties, as well as literally hundreds of banking institutions. It would have been far more valuable if the five-year carryback had existed in 2008 to help mitigate the economic consequences of those failures (and accompanying job losses), rather than after the businesses had already failed. Indeed, our experiences in the bankruptcy profession suggest to us that many of the financial benefits of the extended carryback ultimately inured to creditors, many of whom in these large cases acquired debt claims in bankruptcy, rather than benefitting directly the businesses that needed capital earlier to avoid bankruptcy.

Our views on this issue are not merely theoretical. It has become standard practice in large reorganizations for the bankruptcy courts to implement so-called “trading orders” to preserve the ability of a reorganizing company to utilize its NOLs. The implementation of such orders necessarily includes a finding that the loss of NOLs can impose irreparable harm on the company, its creditors, and its ability to reorganize and preserve jobs. By this legislation, Congress would impose a substantial burden on a struggling company’s ability to use its NOLs, i.e., to use those NOLs to obtain a tax refund for taxes recently paid. Indeed, in certain cases, we have seen tax refunds from NOL carrybacks serve as the source of capital that permits a troubled company to continue as a going concern.

The proposal in the Jobs Act to eliminate NOL carrybacks thus ignores the lessons of both recent and more distant history and fails to appreciate the crucial role that this feature of the Code serves in smoothing the shocks of the business cycle on both businesses and employees. It is simply impossible for Congress to predict accurately when the next economic downturn will come and reinstate the carryback before that occurs. Therefore, the NBC urges Congress to protect the ability to carryback NOLs, furthering the aims of the legislation: assisting taxpayers and promoting job growth.

We understand that Congress may view the elimination of the NOL carryback as a revenue raiser to support other tax reductions. We would emphasize, however, that Congress is also proposing to increase the amount of NOLs by an interest factor that includes the short-term federal rate plus four percentage points. That amendment will provide a tax windfall for healthy companies that are using NOLs after their businesses have improved. We fail to understand the economic wisdom of increasing the value of NOLs for healthy companies, at a cost of harming companies when they most need financial assistance. We would therefore urge Congress to reject this trade-off of NOL carrybacks for future NOL enhancements.

We also would note that the Jobs Act includes a provision that would disallow interest deductions to the extent that they exceed “adjusted taxable income” in any year. This provision will be damaging for troubled companies, because the effect of that provision is to eliminate allowable interest deductions as a company’s earnings fall during an economic downturn. While the NBC has concerns about that provision, we understand and appreciate that Congress may have other reasons for seeking to limit the deductibility of interest. At a minimum, we would urge you to preserve the NOL carryback.¹⁴

If appropriate, we would welcome an opportunity to discuss the proposals addressed in this letter with you and your respective staffs.

Very truly yours
Todd F. Maynes
Chair, NBC Taxation Committee

National Bankruptcy Conference

A non-profit, non-partisan, self-supporting organization of approximately sixty lawyers, law professors and bankruptcy judges who are leading scholars and practitioners in the field of bankruptcy law. Its primary purpose is to advise Congress on the operation of bankruptcy and related laws and any proposed changes to those laws.

History. The National Bankruptcy Conference (NBC) was formed from a nucleus of the nation’s leading bankruptcy scholars and practitioners, who gathered informally in the 1930’s at the request of Congress to assist in the drafting of major Depression-era bankruptcy law amendments, ultimately resulting in the Chandler Act of 1938. The NBC was formalized in the 1940’s and has been a resource to Congress on every significant piece of bankruptcy legislation since that time. Members of the NBC formed the core of the Commission on the Bankruptcy Laws of the United States, which in 1973 proposed the overhaul of our bankruptcy laws that led to enactment of the Bankruptcy Code in 1978, and were heavily involved in the work of the National Bankruptcy Review Commission (NBRC), whose 1997 report initiated the process that led to significant amendments to the Bankruptcy Code in 2005.

Current Members. Membership in the NBC is by invitation only. Among the NBC’s 60 active members are leading bankruptcy scholars at major law schools, as well as current and former judges from eleven different judicial districts and practitioners from leading law firms throughout the country who have been involved in most of the major corporate reorganization cases of the last three decades. The NBC includes leading consumer bankruptcy experts and experts on commercial, employment, pension, mass tort and tax related bankruptcy issues. It also includes former members of the congressional staff who participated in drafting the Bankruptcy Code as originally passed in 1978 and former members and staff of the NBRC. The current members of the NBC and their affiliations are set forth on the second page of this fact sheet.

Policy Positions. The Conference regularly takes substantive positions on issues implicating bankruptcy law and policy. It does not, however, take positions on behalf of any organization or interest group. Instead, the NBC seeks to reach a consensus of its members - who represent a broad spectrum of political and economic perspectives - based on their knowledge and experience as practitioners, judges and scholars. The Conference’s positions are considered in light of the stated goals of our bankruptcy system: debtor rehabilitation, equal treatment of similarly situated creditors, preservation of jobs, prevention of fraud and abuse, and economical insolvency administration. Conferees are always mindful of their mutual pledge to “leave their clients at the door” when they participate in the deliberations of the Conference.

Technical and Advisory Services to Congress. To facilitate the work of Congress, the NBC offers members of Congress, Congressional Committees and their staffs the services of its Conferees as non-partisan technical advisors. These services are offered without regard to any substantive positions the NBC may take on matters of bankruptcy law and policy.