FEI Daily spoke with Diane Tinney, Director of Product Management at Bloomberg BNA Software, about taking advantage of net operating losses (NOLs) to preserve cash flow and reduce tax liabilities.
In the midst of economic growth and corporate profitability, corporate tax departments need to understand how to manage NOLs, but because state NOL rules are complex and vary from state to state, this can be a challenging task.
FEI Daily: What are the key findings of the survey?
Diane Tinney: The economy is coming back and that means that the majority of the corporations that we surveyed are coming into profitable years. They have losses from those years that were less than profitable and it’s good that they have them because they’re a tool that they can use to manage their cash flow. We noticed that a majority of the respondents are actually trying to manage the state NOL area in Excel spreadsheets which is risky. We also saw that they are recognizing the challenges in the state area. Federal is pretty cut and dry, the rules are “vanilla,” whereas when you go into the state area, over a third of the respondents were having trouble with the carryforward and carryback rules when they were trying to manage the NOL area at the state level.
FEI Daily: How does the economy impact NOLs?
Diane Tinney: In 2008, as the economy dove down, companies suddenly found themselves in loss years, needing to cut back the headcount and try to trim here and there, and yet still having losses. That means that their cash flow is short and it could be crippling to a business. I’ve seen businesses that survived 2008 and the dip in the economy that, in the past three years, are buying up the companies that have those losses. So, as the economy is coming back in, companies that are in a good cash position can go out and buy those that have the losses and be able to then shelter their own business and almost fund the purchase of that entity.
FEI Daily: Why are NOLs an important focus for corporate tax teams today?
Diane Tinney: There are two camps. In a loss year, if your business is maybe just starting out or you’ve come into a rough spot, at the state level if you can control the levers of the formula you can maximize the loss during those years, with proper apportionment planning. And then you’re maximizing your loss which means that the asset on your balance sheet is much larger so that when you come into profitable years, you can then shelter your cash flow and be able to infuse your operations: build the factory, hire people. So it’s very important, even in loss years, to have good controls and then, of course, as you get into profitable years you want to be able to plan out the burn down of that asset. Over the next five years, as you come into profitable years, you have options in states as to whether you’re going to use that loss going forward or going back. There are limitations and suspensions and lots of other different ingredients that go into planning out how you will use that asset to shelter cash. Because if you can shelter cash then you can infuse your business with the resources it needs to continue the growth spurt.
FEI Daily: Who typically manages state NOLs? How are they currently doing it?
Diane Tinney: For the most part, you will find that in the corporate tax department, usually there’s a VP of tax, a tax director, and depending on how they silo- sometimes they silo federal separate from state, there might even be a group with a state tax director, manager, etc that are going into the details of the NOL, keeping track of the credits and all those other levers that then feed into how you protect cash.
We found that 68% are just doing it manually in spreadsheets, which means that when they’re looking at the future, at the next five years, they’re kind of putting their thumb up in the air, kind of winging it. Which is scary when it gets into millions of dollars. We came out with a state tax planning tool about a year ago and as people started using it, they came to us and they said “Look, we’ve been doing this NOL stuff in spreadsheets for years. We keep asking compliance vendors to come in and automate this for us, but they can’t do it.”
FEI Daily: What are the risks of using spreadsheets to track, compute and forecast state NOLs?
Diane Tinney: The risks are very similar to what you see in other finance areas. There could be a link from one spreadsheet tab to another tab or a link from a spreadsheet to another workbook on a network and if that file gets moved the link is broken. If somebody accidentally types over a field, you’ve lost the link and all of your formulas change. And there are formula errors, improper rounding. Corporations have even had to restate their financial statements due to a mistake in a spreadsheet. It’s just so easy to do. The last thing is tax professionals and accountants are not necessarily trained in programming and creating safe environments and audit trails within tools, even something as simple as Excel, there is a whole science to it, and so you find very convoluted spreadsheets – formulas that are very, very long and complex and nobody really understands and then the risk is to business continuity. As a finance professional or as CFO you’re looking to get people on staff and be able to survive as people leave. If the brain trust for your NOL workbook on the state area wins the lotto and is no longer there and nobody knows how to use it, what happens is they go back to the drawing board and they reinvent the wheel along with all the other problems that the other workbook have.
FEI Daily: What are some of the main ways corporate tax departments are preserving cash flow and reducing tax liabilities?
Diane Tinney: There are many areas. They can look at credits, and state tax credits are another complex area as are losses. The ability to plan across years and take whatever information you have from the past, learn from it, manage tax audits so that you’re not losing money when the audits happen. Going forward, to be able to manage the interstate liabilities and planning opportunities. If you’re trying to grow your business and you’re looking at different states where you might build the company - Tesla is a great example. They ended up out in Nevada. They were wined and dined by five states but out of those five states Nevada had the best deals for them so that they would be able to protect their cash flows and move forward with their business agenda. We see a lot of companies getting a little bit more aggressive in that area and having software that can be relied upon to quickly model out as you’re going to purchase entities that have attributes like losses and credits and being able to plan that out. Thinking, “What’s the impact of going into this state vs. that state?” or setting up a transaction between states. Big Data is another concept that we hear thrown around a lot, but it has many practical applications in the state tax area.
FEI Daily: What are the biggest NOL management challenges?
Diane Tinney: I’d say that the variety of rules that are about generally accepted accounting principles (GAAP), having to state your books for GAAP purposes. When you do corporate tax you have to convert the GAAP numbers to IRS tax numbers and then you have to restate the IRS numbers to each one of the states because each and every state has a completely different way of doing NOLs and you have to keep track of their changes. So let’s say you have 44 states that you’re doing business in and if you have losses in ten or twelve of those states, you have to track and restate your income and you expense across those years. And as it carries forward and carries back, there are different limitations. Some years are suspended. There are different rules for even how you group your entities. If you’re Starbucks and you have a store on every corner, in some states you have to file separate tax returns, you can’t even comingle the losses within that state. I think that’s one of the biggest challenges and headaches for folks out there, is just keeping track of the tax law changes.
FEI Daily: How can tax teams address the challenges?
Diane Tinney: I would encourage them to find a system that is a third party system where the tax law is already in there and to move out of Excel. I think we saw this in the provision area - and this is going back 8 or 9 years - when the first provision systems came into play and everybody was in Excel and then they slowly moved into the third party systems, which the CPA auditors loved because now there’s an audit trail, plus it saves them the headache of the tax laws.