The new tax law is a boon to most U.S. businesses, but it will make life harder for one type of company: those that are struggling financially or at risk of filing for bankruptcy.
Federal lawmakers killed a key tax benefit that troubled companies have long relied on to raise cash in a pinch. Coupled with a limit on interest deductions, which makes borrowing costlier, the changes will leave strapped firms with fewer options, according to bankruptcy lawyers and advisers.
Financially troubled companies “need the cash to be able to reorganize, pay down creditors and come up with a plan,” said
principal at Crowe Horwath LLP, an accounting firm.
The law eliminated a provision that gave money-losing companies a cash infusion in the form of a retroactive federal tax refund by applying current losses to past tax bills. Experts say these tax breaks, called net operating loss carry-backs, gave companies access to money at a critical time, helping blunt the effect of unexpected slowdowns in the business cycle.
The provision allowed “businesses to ride through short downturns without laying off employees or otherwise harming their operations,” said Connecticut-based bankruptcy lawyer
As Congress considered its tax overhaul, some bankruptcy experts for the National Bankruptcy Conference, a nonprofit policy-monitoring group, warned lawmakers that cutting the carry-backs benefit could hurt employment and economic growth by making it harder for struggling companies to restructure and leading them to lay off more workers.
A spokeswoman for the House Ways and Means Committee said lawmakers considered it important to change the rules for net operating losses to make sure companies couldn’t use them to entirely eliminate a tax bill in a given year.
“The new law ensures greater simplicity, balance, and fairness in our tax code,” she said.
The change will save taxpayer dollars, raising $201 billion over a decade, according to the Joint Committee on Taxation.
Recently, the carry-backs provision gave a boost to struggling jeansmaker True Religion Apparel Inc., which filed for bankruptcy protection in July. The Los Angeles-based retailer requested federal tax refunds for prior years using $21.7 million of the $26.7 million of net operating losses on its books before its bankruptcy filing, according to court documents.
Company officials declined to comment.
who represented some of the retailer’s creditors, said True Religion’s ability to generate that cash helped convince other creditors that the chain should get “a chance for another day.” It emerged from bankruptcy-court protection in October.
“It doesn’t fix the business, but it fixed the balance sheet,” she said of the tax benefits. In its fiscal year ending in January 2017, True Religion reported a net loss of about $78.5 million; court filings in October indicated it had generated positive cash flow over the preceding four months.
Under the new law, companies no longer can carry back net operating losses to get refunds for taxes paid in prior years. Previously, they could seek refunds for federal taxes paid in the previous two years.
Companies still can use losses to offset future tax bills, though with new limits on the amount that can be used each year. Companies can, however, as a new benefit, carry the losses forward to use indefinitely, as opposed to 20 years previously.
Comprehensive data on companies using operating-loss carry-backs aren’t available. But in court documents, lawyers for 34 major companies filing for bankruptcy since March 2015 reported having more than $14 billion in combined net operating losses that could be used for past or future tax savings, according to a Wall Street Journal analysis. The documents don’t indicate the degree to which those losses were used to raise cash.
Oil and gas driller Samson Resources Corp., for example, said in September 2015 that operating losses of $1.4 billion meant it stood to save $515 million on future taxes. Modular Space Corp, which makes temporary offices and storage units, said in December 2016 that its net operating losses of $700 million would save it at least $270 million.
Representatives for Samson and Modular Space didn’t respond to requests for comment.
Carry-backs were first introduced in the late 1910s in the wake of World War I to keep the country’s manufacturing sector strong. The tax benefit has been broadened or restricted by lawmakers in response to numerous economic swings.
The benefit was meant to help companies deal with a tax system that calls for income to be recorded and taxed in a way that doesn’t take times of trouble or growth into consideration. U.S. Supreme Court justices wrote in 1957 that the carry-back and carryforward benefits “were designed to permit a taxpayer to set off its lean years against its lush years.”
Going forward, the changes mean that struggling companies have lost one of the lifelines when figuring out whether survival is possible. “It is a big piece of the puzzle,” said
a St. Louis bankruptcy lawyer at Thompson Coburn LLC law firm.