Naked Credit Implications of The One Big Beautiful Bill Act

As we enter the 2025 year-end tax provision season, careful consideration will be needed to understand how the One Big Beautiful Bill Act (OBBBA) corporate tax changes affect financial statements.  

The tax law brought several favorable changes to businesses, such as the permanent restoration of 100% bonus depreciation and the repeal of mandatory capitalization of domestic R&D. Maybe the most welcome change was the permanent re-instatement of EBITDA based §163(j) interest limitation. This change to the interest limitation rule, however, may require companies to reassess their valuation allowance and naked credit assessments.  

Key Takeaways 

• OBBBA introduces significant changes to corporate tax rules, notably the permanent restoration of EBITDA-based adjusted taxable income (ATI) for interest expense limitations, affecting how companies assess their valuation allowance and naked credit situations. 
• The reintroduction of an EBITDA-based ATI interest limitation in 2025 requires companies to reevaluate their valuation allowance scenarios, with ongoing uncertainty regarding the treatment of double benefits from interest deductions until further Treasury guidance is provided. 

What is a Naked Credit? 

The realizability of DTAs must be evaluated for each period. When a company cannot conclude that the realization of its DTAs is more likely than not, it establishes a valuation allowance. In determining whether a company can realize its DTAs, reversals of existing DTLs can be considered as a source of future taxable income, constituting positive evidence. 

Naked credits exist when a company with a valuation allowance has DTLs that are not expected to reverse in sync with its DTAs. In this situation, those DTLs cannot be considered as a source of future taxable income for the realization of the DTAs. This most commonly occurs with DTLs related to indefinite-lived intangible assets. For tax purposes, intangible assets are typically amortized over 15 years, whereas under GAAP, they may not be amortized at all.  

The most common example of this is goodwill. The basis difference created over time through tax amortization results in a DTL, which is reversed either through the sale or impairment of the intangible asset. Since neither the timing of the sale nor the impairment can be predicted, this DTL is considered indefinite and cannot be used as a source of future taxable income to support definite-lived DTAs. This can result in a valuation allowance exceeding the net DTA, leaving a DTL on the balance sheet, commonly referred to as a naked credit. 

Historical Tax Law Impacts 

The Tax Cuts and Jobs Act (TCJA) of 2017 revised the NOL and disallowed-interest carryforward rules to allow indefinite carryforwards of both attributes. This fundamentally changed the realizability assessment of these DTA’s. Further, this change provided relief to companies in a naked credit position, such that indefinite-lived DTLs could now be considered as a source of future taxable income supporting the realizability of these indefinite-lived attributes.  

However, while the NOL and interest carry forwards post-TCJA provided for an indefinite carryforward period, they also became subject to limitations on their utilization. Post-2017 net operating losses are subject to an 80% of taxable income limitation, while interest carry forwards are limited to a 30% of ATI limitation. Thus, determining the amount of naked credit involves detailed scheduling, not only to determine whether an asset or liability is indefinite, but also to determine how much of an attribute can be considered utilizable.  

This limitation on the utilization of NOLs and interest carryforwards often results in a portion of the indefinite DTL that cannot be offset by the NOL and interest DTA, i.e., a portion that would become a naked credit. 

TCJA Naked Credit Complications Resurfacing 

Treas. Reg. §1.163(j)-1(b)(1)(ii)(C) was introduced after the passage of the TCJA to prevent a duplicate §163(j) tax benefit from both the depreciation and amortization of an asset and upon the later sale of the asset. Between 2018 and 2021, ATI, for purposes of §163(j), was based upon EBITDA. Thus, ATI would be increased through both the initial depreciation and amortization years, and also from the later gain on the sale of the assets.  

The regulation provided that, in a year when there is a gain from the sale of property, ATI must be reduced by depreciation and amortization taken during the EBITDA period from 2018-2021. After 2021 and prior to the passage of the OBBBA, ATI was computed on an EBIT basis, thus avoiding the double benefit issue. 

It is important to note that these regulations only addressed the EBITDA ATI period between December 31, 2017, and January 1, 2022, prior to the passage of the OBBBA. Uncertainty about the treatment of potential double benefits from interest expense deductions after 2024 will persist until the Treasury provides further guidance. 

Naked Credit Considerations 

With the OBBBA’s reintroduction of an EBITDA-based ATI interest limitation in 2025, companies should revisit their existing valuation allowance scheduling scenarios in light of the §163(j) double benefit provisions. Companies will need to understand not only how much amortization occurred during the §163(j) EBITDA period, but also which EBITDA period. Ultimately, Companies may not be able to support the realizability of interest DTAs based upon the reversal of indefinite-lived DTLs.  

Practitioners should also monitor for additional guidance from the Treasury on the double benefit limitation and how it will be applied going forward. 

Still have questions? Read more here with examples and added insights,  Interest Limitation Rules Alter Naked Credit Determinations, or connect with our team using the form below.