Charitable carryover adjustment uses annual NOL absorption and current contributions first

Plain-English summary

A corporation had multiple years of net operating loss carryovers and charitable contribution carryovers available in a year when one charitable carryover was about to expire. Chief Counsel advised that the section 170(d)(2)(B) adjustment, which prevents a charitable contribution from both increasing an NOL carryover and remaining available as a charitable carryover, must follow section 172(b)(2)'s chronological year-by-year NOL absorption calculation rather than an aggregate method. Counsel also concluded that current-year charitable contributions must be reduced first because they are the contributions that reduce modified taxable income and increase the NOL carryover. The taxpayer could not instead reduce an expiring prior-year charitable carryover to preserve it.

Ruling snapshot

• Question: Must the section 170(d)(2)(B) charitable carryover adjustment use year-by-year NOL absorption, and which contributions are reduced first?
• Outcome: Advice: calculate NOL absorption chronologically and reduce current-year charitable contributions before prior-year carryovers.
• Key authorities: IRC §§ 170 and 172; Treas. Reg. §§ 1.172-5 and 1.172-6; Rev. Rul. 76-145

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           memorandum
           Number: 201928014
           Release Date: 7/12/2019
           CC:ITA:B01:JLTrebat
           POSTU-122569-17

 UILC:     170.10-02, 172.01-00

  date:    November 01, 2018

     to:   Teri L. Jackson
           Attorney (St. Paul, MN)
           (Large Business & International)

  from:    Ronald J. Goldstein
           Assistant to the Branch Chief, Branch 1
           Office of Associate Chief Counsel
           (Income Tax & Accounting)

subject:   I.R.C. § 170(d)(2)(B) Charitable Contribution Carryover Adjustment

           This Chief Counsel Advice responds to your request for assistance. This advice may
           not be used or cited as precedent.

           LEGEND

           Taxpayer     =   ------------------------------
           Year 1       =   -------
           Year 2       =   -------
           Year 3       =   -------
           Year 4       =   -------
           Year 5       =   -------
           Amount 1     =   ----------------------
           Amount 2     =   ------------------
           Amount 3     =   ----------------
           Amount 4     =   -------------------
           Amount 5     =   ------------------

POSTU-122569-17                             2

Amount 6      =   ------------------
Amount 7      =   -------------------
Amount 8      =   ----------------
Amount 9      =   ------------------

ISSUES

(1) Taxpayer has both charitable contribution and net operating loss carryovers from
multiple tax years available in the year at issue. Section 170(d)(2)(B) requires a
reduction to a taxpayer’s charitable contribution carryover to the extent an excess
charitable contribution reduces modified taxable income (as computed under
§ 172(b)(2)) and increases an NOL carryover, so as to eliminate a double tax benefit. Is
Taxpayer required to calculate the charitable contribution carryover adjustment using a
year-by-year or an aggregate NOL computation under § 172(b)(2)?

(2) Taxpayer has a charitable contribution carryover set to expire in the year at issue
pursuant to the five-year carryover period provided in § 170(d)(2). Section 170(d)(2)(B)
requires a reduction to a taxpayer’s charitable contribution carryover to the extent an
excess charitable contribution reduces modified taxable income (as computed under
§ 172(b)(2)) and increases an NOL carryover. Is Taxpayer required to reduce its
current year charitable contributions first or can it choose to reduce a prior year’s
charitable contribution carryover to prevent its expiration?

CONCLUSIONS

(1) Section 172(b)(2) requires Taxpayer to use a year-by-year NOL absorption
computation to determine the charitable contribution carryover adjustment under
§ 170(d)(2)(B).

(2) Taxpayer must first reduce its current year charitable contributions by the adjustment
under § 170(d)(2)(B) before reducing its earliest year’s charitable contribution carryover.

FACTS

Taxpayer is a corporation that had several years of net operating loss carryovers (NOL
carryovers) and charitable contribution carryovers (charitable carryovers) that were
available to use in Year 1, the year at issue. The NOL carryovers totaled Amount 1 and
the charitable carryovers totaled Amount 2. The charitable carryovers included Amount
3 from Year 2, which had not been utilized for four consecutive years and was
scheduled to expire at the end of Year 1 if not utilized.

In Year 1, Taxpayer generated taxable income of Amount 4 before considering its NOL
carryovers. Also in Year 1, Taxpayer made charitable contributions of Amount 5. All of
Taxpayer’s Year 1 taxable income was offset by its NOL carryovers reducing its taxable

POSTU-122569-17                              3

income to $0. As a result, Taxpayer was not allowed to deduct any charitable
contributions in Year 1. Taxpayer had additional unused NOL and charitable carryovers
available for use in the following year, Year 3.

LAW AND ANALYSIS

Section 170(a) of the Internal Revenue Code allows a deduction for charitable
contributions paid within the taxable year. Section 170(b)(2) limits a corporation’s
current charitable contribution deduction to ten percent of its taxable income (the 10%
limit). Taxable income is computed for purposes of § 170(b)(2) without regard to the
charitable contribution deduction or any NOL carryback to the taxable year. NOL
carryovers are taken into account when calculating taxable income for purposes of
determining the 10% limit.

Section 170(d)(2) provides for a carryover of charitable contributions a corporation
makes in a taxable year that exceed the 10% limit. In determining which charitable
contributions are deductible in a taxable year, current year contributions are deducted
first. If current year contributions are less than the 10% limit, carryover contributions are
taken into account in the order in which they arose. The maximum carryover period for
charitable contributions is five taxable years.

Section 172(a) of the Internal Revenue Code allows a deduction for any NOLs carried
back and carried forward to a taxable year. Section 172(b)(1) sets forth the years to
which an NOL may be carried, while § 172(b)(2) specifies how to compute the amount
of the NOL that is carried to those years. Section 172(b)(2) provides that an NOL shall
be carried to the earliest year available. Once carried to the earliest taxable year
available, all or a portion of the NOL is used up or absorbed. The amount of an NOL
that is absorbed in a taxable year equals a taxpayer’s modified taxable income—taxable
income for that year determined with certain modifications pursuant to § 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 modified taxable income is carried to the next
taxable year.

Under § 172(b)(2), modified taxable income is determined without taking into account
the NOL to be absorbed or NOLs incurred in taxable years that are after the taxable
year of the NOL to be absorbed. Treas. Reg. § 1.172-5(a)(2)(ii). However, NOLs
carried from years before the taxable year of the NOL to be absorbed are considered in
determining modified taxable income, as are charitable contribution deductions. Section
1.172-6 illustrates this year-by-year NOL absorption and carryover calculation. If an
NOL deduction reduces a taxpayer’s taxable income to $0, no charitable contribution
deduction is allowable for that taxable year.

As a result of these provisions, more charitable contributions may be allowable in
computing modified taxable income under § 172(b)(2) than are allowable in computing
taxable income under § 170(b)(2). By reducing modified taxable income, these

POSTU-122569-17                             4

charitable contributions result in less NOL being absorbed than the actual amount of
NOL used to reduce taxable income. Thus, the additional charitable contributions
allowed in determining modified taxable income increase the amount of NOL carryovers
to a subsequent taxable year.

The additional charitable contributions that are allowed in computing modified taxable
income are not actually deducted when a taxpayer computes taxable income. If these
additional amounts were allowed as charitable carryovers, then the contributions would
produce a double tax benefit by reducing the amount of the NOL absorbed (which
increases the NOL carryover) and also remaining available in a subsequent taxable
year as a charitable contribution deduction. Section 170(d)(2)(B) exists to prevent this
result and provides that charitable carryovers must be reduced to the extent that an
excess charitable contribution reduces modified taxable income in the absorption
calculation of § 172(b)(2) and increases an NOL carryover to a succeeding year under
§ 172 (the § 170(d)(2)(B) adjustment). The effect of these provisions is that some
charitable contributions with a five-year carryover period are converted into an NOL with
a twenty-year carryover period.

Issue 1

Exam asserts that the § 170(d)(2)(B) adjustment must be calculated for each taxable
year an NOL carryover is absorbed, beginning with the earliest NOL available for use in
the taxable year. Thus, Exam applied the 10% limit to Amount 6 (Amount 4 less
Amount 7). Ten percent of Amount 6 equals Amount 8.

Taxpayer’s position is that the § 170(d)(2)(B) adjustment should be calculated on an
aggregate basis. As a result, Taxpayer did not apply a year-by-year analysis of the
§ 170(d)(2)(B) adjustment. Taxpayer applied the 10% limit to the Year 1 taxable income
of Amount 4, which equals Amount 9. Amount 9 is greater than Amount 8, and under
Taxpayer’s method, Taxpayer would be entitled to a larger § 170(d)(2)(B) adjustment
than allowed by Exam.

Section 172(b)(2) requires a chronological, year-by-year, NOL absorption computation.
Section 1.172-6 illustrates the year-by-year NOL absorption and carryover calculation.
Applying an aggregate basis standard is incorrect. In determining modified taxable
income, Taxpayer was required to take into account the Year 4 NOL carryover of
Amount 7. The NOL to be absorbed (part of the Year 5 NOL carryover) is not taken into
account in determining modified taxable income. Accordingly, the § 170(d)(2)(B)
adjustment is Amount 8.

Issue 2

Taxpayer and Exam disagree on which charitable contributions must be reduced
pursuant to the § 170(d)(2)(B) adjustment. Exam asserts that Taxpayer must first
reduce the Year 1 charitable contributions by the § 170(d)(2)(B) adjustment. If a

POSTU-122569-17                             5

§ 170(d)(2)(B) adjustment remained after reducing the Year 1 charitable contributions to
$0, then Taxpayer would reduce its charitable carryovers starting with the earliest year.
In this case, the Year 1 charitable contributions of Amount 5 are greater than the
§ 170(d)(2)(B) adjustment, so no charitable carryovers are taken into account in
computing the § 170(d)(2)(B) adjustment.

Taxpayer contends that § 170(d)(2)(B) does not address which charitable contributions
must be reduced first so it should be able to use any reasonable method. Thus, in
computing the § 170(d)(2)(B) adjustment, Taxpayer reduced its expiring charitable
carryovers from Year 2 rather than the charitable contributions made in Year 1.

As described above, the Year 1 charitable contributions must be reduced first. The
rules of §§ 170 and 172 and the regulations thereunder, which must be read in
conjunction, dictate that current year charitable contributions rather than charitable
carryovers are taken into account in the § 172(b)(2) calculation that reduces modified
taxable income and increases the NOL carryover. As a result, it is the current year
charitable contributions that trigger the § 170(d)(2)(B) adjustment and must therefore be
reduced.

Taxpayer cites Revenue Ruling 76-145 for the proposition that current year charitable
contributions and all charitable carryovers are co-equal, fungible elements of “excess
contributions,” and each is an equally viable option to be reduced first or last.

In Revenue Ruling 76-145, the current year charitable contributions were $2, but the
applicable percentage limit was $5. Thus, the current year charitable contributions of $2
plus the charitable carryover of $3, together, had to be taken into account in calculating
the § 170(d)(2)(B) adjustment because the $2 and the $3, together, reduced modified
taxable income in the absorption calculation of § 172(b)(2) and increased the NOL
carryover to a succeeding year under § 172. If the current year charitable contributions
were also $3, then the current year charitable contributions would be reduced first by
operation of § 170(d)(2)(B), and there would be $1 left of the charitable carryover.

In Taxpayer’s case, the Year 1 charitable contributions of Amount 5 are greater than the
10% limit of Amount 8. Thus, only the Year 1 charitable contributions of Amount 5 are
taken into account in calculating the § 170(d)(2)(B) adjustment because Amount 5 alone
reduced modified taxable income in the § 172(b)(2) absorption calculation thereby
increasing the NOL carryover to a succeeding year. Accordingly, the result in Revenue
Ruling 76-145 and the result in this case are not inconsistent; rather, the facts merely
dictate a different result. If the facts of this case were such that the 10% limit was
greater than the current year charitable contributions, then Taxpayer would add the
amount of the earliest year’s charitable carryover to the current year charitable
contributions to the extent the charitable carryover also reduced modified taxable
income in the absorption calculation of § 172(b)(2) and increased the NOL carryover to
a succeeding year under § 172.

POSTU-122569-17                             6

Here, to the extent the charitable contributions in Year 1 reduced modified taxable
income in the absorption calculation of § 172(b)(2) and increased the NOL carryover to
Year 3, the charitable carryover must be reduced by the amount of the Year 1 charitable
contributions that increased the NOL carryover. Amount 8 of the Year 1 charitable
contributions reduced modified taxable income and, thus, increased the NOL carryover
so that the remainder should be carried over to Year 3.

Moreover, because the Year 2 charitable carryover expires in Year 1, it is not an excess
contribution under § 170(d)(2)(A). The charitable carryover from Year 2 may not be
used because of the expiration of the five-year statute of limitations period.

The rules and analysis can be explained by this simplified example. 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. X Corp also had charitable
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, like in Taxpayer’s case, X Corp cannot deduct any charitable
contributions in 2017 because the NOL carryovers reduce taxable income for 2017 to
$0. But, like Taxpayer, X Corp still must compute the 10% limit for purposes of
determining modified taxable income 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
§ 170 taxable income ($1,000-$100=$900). X Corp must then multiply its § 170 taxable
income by the 10% limitation ($900x.10=$90). The $90 represents the amount of the
2017 charitable contribution that is allowed for purposes of calculating modified taxable
income under § 172(b)(2).

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 § 170(d)(2)(B) adjustment. X
Corp must reduce its 2017 charitable contributions by $90 because that amount was
allowed in the modified taxable income 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 § 172(b)(2) and the amount carried over to 2018. The 2013 NOL carryover is
reduced by the amount absorbed, which is the 2017 modified taxable income, and the
remainder is carried over to 2018 ($1,500-$810=$690).

POSTU-122569-17                              7

In this example, like in Taxpayer’s case, only the current year charitable contributions
are taken into account in calculating the § 170(d)(2)(B) adjustment because the current
year charitable contributions alone reduced modified taxable income in the absorption
calculation of § 172(b)(2) and increased the NOL carryover to a succeeding year under
§ 172. Accordingly, X Corp loses the ability to use any charitable carryovers from 2012
as a result of the expiration of the five-year statute of limitations period.

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