26 CFR 1.59A-4 – Modified taxable income
(a) Scope. Paragraph (b)(1) of this section provides rules for computing modified taxable income. Paragraph (b)(2) of this section provides rules addressing how base erosion tax benefits and net operating losses affect modified taxable income. Paragraph (b)(3) of this section provides a rule for a holder of a residual interest in a REMIC. Paragraph (c) of this section provides examples illustrating the rules described in this section.
(b) Computation of modified taxable income—(1) In general. The term modified taxable income means a taxpayer’s taxable income, as defined in section 63(a), determined with the additions described in paragraph (b)(2) of this section. Notwithstanding the foregoing, the taxpayer’s taxable income may not be reduced to an amount less than zero as a result of a net operating loss deduction allowed under section 172. See paragraphs (c)(1) and (2) of this section (Examples 1 and 2).
(2) Modifications to taxable income. The amounts described in this paragraph (b)(2) are added back to a taxpayer’s taxable income to determine its modified taxable income.
(i) Base erosion tax benefits. The amount of any base erosion tax benefit as defined in § 1.59A-3(c)(1).
(ii) Certain net operating loss deductions. The base erosion percentage, as described in § 1.59A-2(e)(3), of any net operating loss deduction allowed to the taxpayer under section 172 for the taxable year. For purposes of determining modified taxable income, the net operating loss deduction allowed does not exceed taxable income before taking into account the net operating loss deduction. See paragraph (c)(1) and (2) of this section (Examples 1 and 2). The base erosion percentage for the taxable year that the net operating loss arose is used to determine the addition under this paragraph (b)(2)(ii). For a net operating loss that arose in a taxable year beginning before January 1, 2018, the base erosion percentage for the taxable year is zero.
(3) Rule for holders of a residual interest in a REMIC. For purposes of paragraph (b)(1) of this section, the limitation in section 860E(a)(1) is not taken into account in determining the taxable income amount that is used to compute modified taxable income for the taxable year.
(c) Examples. The following examples illustrate the rules of paragraph (b) of this section.
(1) Example 1: Current year loss—(i) Facts. A domestic corporation (DC) is an applicable taxpayer that has a calendar taxable year. In 2020, DC has gross income of $100x, a deduction of $80x that is not a base erosion tax benefit, and a deduction of $70x that is a base erosion tax benefit. In addition, DC has a net operating loss carryforward to 2020 of $400x that arose in 2016.
(ii) Analysis. DC’s starting point for computing modified taxable income is $(50x), computed as gross income of $100x, less a deduction of $80x (non-base erosion tax benefit) and a deduction of $70x (base erosion tax benefit). Under paragraph (b)(2)(ii) of this section, DC’s starting point for computing modified taxable income does not take into account the $400x net operating loss carryforward because the allowable deductions for 2020, not counting the NOL deduction, exceed the gross income for 2020. DC’s modified taxable income for 2020 is $20x, computed as $(50x) + $70x base erosion tax benefit.
(2) Example 2: Net operating loss deduction—(i) Facts. The facts are the same as in paragraph (c)(1)(i) of this section (the facts in Example 1), except that DC’s gross income in 2020 is $500x.
(ii) Analysis. DC’s starting point for computing modified taxable income is $0x, computed as gross income of $500x, less: A deduction of $80x (non-base erosion tax benefit), a deduction of $70x (base erosion tax benefit), and a net operating loss deduction of $350x (which is the amount of taxable income before taking into account the net operating loss deduction, as provided in paragraph (b)(2)(ii) of this section ($500x?$150x)). DC’s modified taxable income for 2020 is $70x, computed as $0x + $70x base erosion tax benefit. DC’s modified taxable income is not increased as a result of the $350x net operating loss deduction in 2020 because the base erosion percentage of the net operating loss that arose in 2016 is zero under paragraph (b)(2)(ii) of this section.