Tax reform could make losses sting even more
There are plenty of things for businesses to love about the Republican tax cut proposal that President Donald Trump and GOP leaders hope to rush through Congress by the end of the year.
Lowering the corporate tax rate from 35 percent to 20 percent. The ability to immediately expense the cost of new plants and equipment instead of writing them off over a number of years. And not being taxed on overseas profits save for a 10 percent tax on offshore subsidiaries that are significantly profitable.
But there’s one small item that could cause some heartburn for companies with a losing track record — including chronically cyclical industries like steel and startups struggling to turn a profit.
Current tax law allows corporations to use past losses to offset income they make in future years. In accounting speak, they are called net operating loss carryforwards, or NOLs for short.
“Those are clearly huge potential tax benefits waiting to happen in the future,” said Joseph P. Nicola Jr., a tax partner at Sisterson & Co., Downtown.
Mr. Nicola explained how they work: if a company has $1 million in NOLs from prior years, then reports taxable income of $400,000, it can use $400,000 from the NOLs to reduce its taxable income for the current year to zero.
Companies are required to carry net operating loss carryforwards on their books as a deferred tax asset with a value based on how much of a tax benefit they are estimated to provide in the future.
Under the Republican tax plan, companies would have to lower the value of their NOLs because getting a break on future profits that would be taxed at 20 percent would not be worth as much as a break on future profits taxed at 35 percent.
Dan Phillips, a shareholder in the tax advisory services unit of Schneider Downs, Downtown, said with a 35 percent rate, $10 million in NOLs would have a value of $3.5 million. But they would only be
worth $2 million if the federal tax rate was cut to 20 percent, Mr. Phillips said.
To reflect the drop in the value being carried on the books, the company in that example would have to take a $1.5 million charge against earnings, he said.
Mr. Nicola said the tax plan would put further restrictions on using past losses to reduce future taxable income. The proposal would only allow companies to use NOLs to offset 90 percent of their taxable income. So instead of using $400,000 in NOLs to offset the $400,000 profit, the company could only reduce its taxable income by $360,000.
The potential impact caught the eye of long-time metals industry analyst Charles Bradford. He asked U.S. Steel about it during a conference call discussing the steelmaker’s $147 million third quarter profit.
Since U.S. Steel has only posted one profitable year since the Great Recession of 2008, the Pittsburgh company has a lot of NOLs on its books — $754 million at the end of last year, according to securities filings.
Mr. Bradford asked whether the company would have to write down the value of those should the corporate tax rate be cut to 20 percent. President and CEO Dave Burritt told him it’s too early to tell.
“We think overall tax reform is a good thing,” Mr. Burritt responded. “It will be good for the economy and, therefore, good for us.”
There’s another factor. If a company determines that it is unlikely it will ever generate enough profits to take advantage of its NOLs, then it has to write down the value that it doesn’t expect to be able to put to work in the future.
Taxes being the complex beast they are, it’s hard to get the big picture of how the proposal would affect a company’s federal tax bill given all of the other moving pieces of the puzzle.
Net operating loss carryforwards are only one taxrelated asset that companies carry on their books and hope to realize on their income statements in future years. In addition to these deferred tax assets, companies also have deferred tax liabilities whose value would decrease — that would be a good thing — if the tax rate was reduced, Mr. Phillips said.
He said most companies are focusing on the immediate impact that the plan would have on their current tax expense, rather than the deferred tax effects.
Most expect the Republican proposal will be reworked and may not even make it through Congress this year. In the meantime, dissecting what the complex plan would mean for deficits and funding priorities like Social Security is a job for accountants and economists. Hopefully, there are a few of them in Congress who know what they’re doing.