NOL Deduction not required to be used when Tax is on Capital – NYS Corporation Tax

By Brian Gordon

In a recent case before an administrative law judge (ALJ), a taxpayer, TD Holdings II, Inc. (TD Holdings), protested an assessment of franchise tax on banking corporations under Article 32 of the Tax Law for the fiscal year ended October 31, 2007 involving a Net Operating Loss (NOL) deduction.

In 2005 TD Holdings incurred a NOL for both federal and New York state tax purposes. In 2006 they used a NOL deduction for federal purposes, but not for state since they paid tax on the Capital base. Tax on capital was higher than the resulting tax on income would have been. As such, they saw no need to “waste” the NOL deduction. TD Holdings then had more available and used the balance of their NOL deduction in 2007.

New York took issue with that methodology saying that TD Holdings must use part of their NOL deduction in 2006, matching the federal deduction. As a result, the state assessed TD Holdings in 2007 as they said they had less NOL deduction available for use.

What makes this case interesting, and what is important for all readers to know is that under the new New York State corporate tax reform effective 1/1/15 this is no longer an issue.

Under article 9A corporation tax law, New York State taxes corporations on the highest of three methods of calculating tax: Tax on Income, Tax on Capital and a Fixed Dollar Minimum Tax.

Banks now also file under article 9A with general business corporations. The new law now clearly states that NOL deductions should only reduce taxable income to the extent that the resulting tax on income would equal the tax on one of the other bases. Do not bring your taxable income down to zero.

You are not required to "waste" your net operating loss by deducting it from income in a year that tax is computed on Capital or on the Minimum Tax bases. Part of the reason for this change is that New York NOL deductions are no longer coupled with federal NOL deductions.

This brings us back to the case at hand. Prior to 2015 the New York state NOL deduction could not exceed the federal deduction, even if there was more state income than federal. The ALJ determined, in finding in favor of TD Holdings that didn’t mean a corporation was required to take the same deduction as for federal purposes, they just couldn’t exceed it. In fact they didn’t have to take a deduction at all (if tax was on capital).

According to the ALJ, the state erred, because they were relying on the federal rules for NOL deductions. They didn’t recognize that federal corporate income tax is always based on income, while the state tax can be based on something other than income. An ALJ determination is not precedent setting, but it does provide guidance.

My primary point here is that the state has recognized in the new law that we should not have to waste our NOLs, when tax is not based on income. The TD Holdings decision is still helpful, because a corporation may have NOLs available for carryforward from years prior to 2015.

For more information regarding State and Local Taxes, please visit
Brian Gordon's S.A.L.T Blog at:
www.st-cpas.com/blog.