Interest Deductions

Interest Deductions

November 01, 2012

Interest deductions may be hard to carry back.

The US tax laws allow net operating losses to be carried back two years and forward for 20 years until they are used. A company carrying back losses can get a refund from the US Treasury.

Congress took steps in 1989 to prevent corporations from engaging in leveraged buyout transactions and then carrying back the interest deductions on debt borrowed to finance the buyouts. It did not want the Treasury helping to fund the buyouts. However, the restriction was drafted more broadly.

Twenty-three years later, the IRS issued proposed regulations in September to explain when interest deductions cannot be carried back.

The restriction is in section 172(b)(1) and (h) of the US tax code.

It will apply to any corporation that acquired at least 50% of another corporation during a year, had at least 50% of its shares acquired or made unusually large cash distributions to shareholders during the course of the year. Cash distributions are unusually large if they are at least 10% of the market value of the corporation’s stock at the start of the year or, if greater, 150% of the average annual cash distributions the corporation made to shareholders during the three prior tax years.

The IRS said it will not try to trace the debt used to fund the stock purchase or cash distributions, but rather will block any carryback of the extra interest expense the corporation is claiming above the average interest expense it claimed during the three prior years. The restriction also applies to the extra interest expense in each of the next two years after the stock purchase or cash distributions.

The new rules come with two acronyms. A “CERT” is a transaction that brings the rules into play. It stands for “corporate equity reduction transaction.” A “CERIL” is the interest deductions that cannot be carried back. It stands for “corporate equity reduction interest loss.”

by Keith Martin