Beware of State-Federal NOL Differences

State net operating loss (NOL) rules generally differ from federal NOL rules, and state NOL rules often differ from one another. This is especially true with respect to carrybacks of NOLs--which, unlike for federal returns, the majority of states do not allow--and carryforwards. This lack of consistency can lead to confusion about a taxpayer's ability to use NOLs. FEDERAL NOL REGIME IRC [section] 172(b)(1)(A) allows taxpayers to carry NOLs back two and forward 20 years, unless a taxpayer elects to waive the carryback period, in which case NOLs will only be carried forward. Legislation enacted in 2009 allows most corporate taxpayers to elect to carry back 2008 or 2009 NOLs up to five years. STATE NOL COMPUTATION AND APPLICATION DIFFERENCES Computing state taxable income generally begins with either federal taxable income before NOL and special deductions (from line 28 of the 2009 Form 1120, U.S. Corporation Income Tax Return) or federal taxable income after NOL and special deductions (from line 30). The applicable federal starting point is modified to reflect certain addition and subtraction adjustments, such as the acid-back of expenses not deductible and the subtraction of income not taxable at the state level. Taxpayers should consider a number of common NOL variations. In general, states require a taxpayer to have nexus (that is, be subject to tax) in the state in the year a loss is generated to carry over that loss to a subsequent tax year. Some states specifically require nexus in a loss year to claim an NOL carryover. For example, Maryland regulations provide that a taxpayer cannot use an NOL generated when a corporation is not subject to Maryland income tax law as a deduction to offset Maryland income in a carryover year (Md. Code Regs. [section] 03.04.03.07(A)(5)). A similar rule applies in Rhode Island (R.I. Gen. Laws [section] 44-11-11(b)). Most states require nexus implicitly, by limiting carryforward or carryback amounts by taxpayers' income apportionment factor in the loss year between or among themselves and one or more other states. For example, Georgia requires a corporation doing business within and outside Georgia to compute the NOL carryover deduction based on the corporation's apportionment formula in the loss year (Ga. Code Ann. [section] 48-7-21). Iowa applies a similar rule (Iowa Code [section] 422.35(11)(g)). New York law takes the "subject to tax" restriction one step further and provides that a taxpayer must be subject to the same article of the New York tax law in both the loss year and the carryover year to claim an NOL deduction (N.Y. Tax Law [section] 208(9)(f)(2)). Accordingly, if a taxpayer is subject to the Article 32 bank franchise tax based on income in the year an NOL is generated and the Article 9-A corporate franchise tax on income in the year it seeks to claim an NOL carryover, no deduction is permitted. In contrast, Virginia, which does not have its own NOL provisions but relies on federal NOL provisions in computing state taxable income, does not require nexus in the loss year; thus, Virginia taxpayers may "import" NOLs from non-nexus years. In determining state taxable income, states require a number of addition and subtraction modifications to federal taxable income. State-specific modifications may result in significant differences between federal and state taxable income, such as where a state "decouples" from bonus depreciation provisions or from the cancellation-of-debt income elective deferral provisions. As a result, while taxpayers may have an NOL for federal purposes in a given tax year, they may have taxable income at the state level in that year. Even if the state-specific adjustments do not cause a taxpayer to be in a net income position for state purposes, they may significantly reduce the NOL from the federal amount. Most states limit the amount of loss that a taxpayer can carry over based on the taxpayer's level of in-state activity in the loss year. …

Field of study: Business