The New York State Department of Taxation and Finance (Tax Department) recently released draft amended corporate franchise tax regulations under Article 9-A of the New York Tax Law (N.Y. Comp. Codes and Regs. tit. 20, Subpart 3-7) (Draft Regulations), which address the treatment and calculation of New York investment capital losses and business capital losses from tax years beginning on or after January 1, 2015, and capital losses from pre-2015 tax years.

Specifically, for tax years beginning on or after January 1, 2015, in which a corporation incurs capital losses and gains, under the New York Tax Law, the corporation could only use New York investment capital losses to offset New York investment capital gains, and New York business capital losses to offset New York business capital gains. Comments on the Draft Regulations are due September 16, 2019; however, the Tax Department has indicated that it will accept and consider comments submitted after the due date.¹

Definitions: New York investment capital gains or losses and New York business capital gains or losses in tax years beginning on or after January 1, 2015 (Draft Regulation Subparts 3-7.1 and 3-7.2)

The Draft Regulations define key terms, including New York investment capital gains or losses, New York net investment capital gains and losses, New York business capital gains or losses, and New York net business capital gains and losses. Further, they provide that New York investment capital² gains or losses and New York business capital gains or losses do not include any amount of federal capital gains or losses sustained in a year in which a corporation is: (1) not a taxpayer or member of a New York combined group (a New York non-filing year); (2) a New York S corporation, a taxpayer that has made an election under subchapter S of Chapter one of the Internal Revenue Code and/or N.Y. State Tax Law Section  660(a) (a New York S year); (3) a "non-captive REIT" (a non-captive REIT filing year); (4) a "non-captive RIC" (a non-captive RIC filing year); or (5) a captive insurance company that is not a combinable captive (a non-combinable captive insurance filing year).

Federal net capital loss sustained in pre-2015 tax years (Draft Regulation Subpart 3-7.3)

Generally, federal net capital losses from a tax year beginning before January 1, 2015, would be carried back and forward as required by the rules under Article 9-A and Article 32 as such rules existed on December 31, 2014. However, federal net capital losses from a pre-2015 tax year carried to a tax year beginning after December 31, 2014, would be subject to the Draft Regulations. Additionally, any federal net capital loss available for carryforward as of the end of the last tax year beginning before January 1, 2015, would be deemed to be a New York net business capital loss (regardless of whether it was from business capital, investment capital or subsidiary capital under prior regulations) that could be carried forward to the next tax year beginning on or after January 1, 2015, and would be applied only against New York business capital gains, provided it does not increase or produce a New York State net operating loss (NOL). Any such New York net business capital loss would only be carried forward for five taxable years succeeding the loss year.

Capital losses sustained in tax years beginning on or after January 1, 2015 (Draft Regulation Subpart 3-7.4)

In computing the business income base for New York tax purposes, taxpayers would not be allowed to offset investment capital losses with business capital gains or offset business capital losses with investment capital gains. Therefore, federal capital gains and losses would need to be reclassified as New York business capital gains or losses and New York investment capital gains or losses. As a result of this reclassification, and to calculate the New York business income base, federal taxable income would be increased for the amount of New York net investment capital loss that offsets New York business capital gains or for the amount of New York net business capital loss that offsets New York investment capital gains.

Additionally, if federal capital losses sustained in a New York non-filing year are used on a federal return in a year in which a corporation is subject to New York corporate franchise tax or is a member of a combined group (i.e., a New York filing year), federal taxable income in that New York filing year would be increased by the amount of federal capital loss that was used from that New York non-filing year. Similar provisions requiring federal taxable income to be increased would apply for amounts of federal capital loss sustained in (1) a New York S year used on a federal return in a New York C year, (2) a non-captive REIT filing year used on a federal return in a captive REIT filing year, (3) a non-captive RIC filing year used on a federal return in a captive RIC filing year, and (4) a non-combinable captive insurance filing year that is used on a federal return in a combinable captive insurance filing year.³

Application of New York net capital losses (Draft Regulation Subpart 3-7.5)

Generally, New York net business capital loss and New York net investment capital loss would be carried back to each of the three tax years immediately before the tax year of each loss, and then could be carried forward to the next five tax years after the tax year of each loss, but only to the extent that they would not increase or produce a New York State NOL. However, under the Draft Regulations, a New York net business capital loss or a New York net investment capital loss would not be allowed to be carried back to a pre-2015 tax year. New York net business capital loss would only offset New York business capital gains, and New York net investment capital loss would only offset New York investment capital gains. In determining the number of tax years to which a capital loss may be carried back or forward, the following years would be counted: (1) a New York filing year; (2) a New York non-filing year; (3) a New York S filing year; (4) a non-captive REIT filing year; (5) a non-captive RIC filing year; and (6) a non-combinable captive insurance filing year.

If a corporation is included in a federal consolidated return but files on a separate company basis for New York purposes, it would compute its New York net business capital loss and New York net investment capital loss as if it filed separately for federal income tax purposes and would follow these regulations to calculate its New York net investment capital gain or loss and New York net business capital gain or loss. For New York combined filing purposes, if a New York State combined group differs from the federal consolidated group, the New York combined group would recalculate federal taxable income to reflect the New York State combined group members, and then would compute its New York net business capital loss and New York net investment capital loss as if all the corporations in the New York combined group were a single corporation.

Capital losses in combined reports (Draft Regulation Subpart 3-7.6)

If a corporation is a member of a combined group for any tax year beginning on or after January 1, 2015, and later leaves the group, that member would take with it its share of the combined group's New York net business capital loss carryover and New York net investment capital loss carryover. The Draft Regulations detail how such a departing member would calculate its share of New York net business capital loss carryover and New York net investment capital loss carryover. A departing member could then file a separate New York return, or join a new combined group (adding its capital loss carryover amounts to those of the new combined group's).

Record keeping and examples (Draft Regulation Subparts 3-7.7 and 3-7.8)

To claim a New York net capital loss carryback or carryforward (either business or investment), a taxpayer or combined group would be required to submit a copy of its federal capital gains and losses schedule used and a schedule of New York capital gains and losses used for the loss year and for any year(s) to which the losses are carried. The Draft Regulations also provide examples to illustrate how the rules would be applied.

Implications

The Draft Regulations are intended by the Tax Department to provide some clarity to taxpayers on the computation and utilization of capital losses for New York purposes. As previously noted, comments on the Draft Regulations are due to the Tax Department by September 16, 2019, but the Tax Department may accept comments after that time. Taxpayers are advised that they should not rely upon the Draft Regulations until they are finalized. New York City has indicated it will follow the New York State regulations once they are finalized, to the extent that New York State and New York City law are the same.

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ENDNOTES

¹ N.Y. Dept. of Taxn. and Fin., Corporate tax reform draft regulations (last visited June 19, 2018).

² The Draft Regulations omit the word "capital" but that omission appears to be a typographical error.

³ With respect to (4), the Draft Regulations omit the word "insurance" but that omission appears to be a typographical error.