July 20, 2020
New York State issues draft regulations on net operating losses
The New York State (NYS) Department of Taxation and Finance (Tax Department) has posted for comment new draft corporate franchise tax regulations under Article 9-A of the New York Tax Law (to be codified at N.Y. Comp. Codes and Regs. tit. 20, Subparts 3-10.1 through 3-10.8), which would add rules on net operating losses (NOLs) and NOL deductions (NOLDs) for tax years beginning on or after January 1, 2015 (hereafter, draft regulations). These draft regulations, if finalized, would repeal existing regulations related to NOLDs under N.Y. Comp. Codes and Regs. tit. 20, Subpart 3-8.1 through 3-8.9, but the repealed regulations would still apply to tax years beginning before January 1, 2015.
The Tax Department has requested comments on the draft regulations by October 5, 2020, but said on its website that it may still consider comments submitted after the due date. The draft regulations contain examples explaining the new rules, including:
The draft regulations define "net operating loss" as the business loss amount incurred in a particular tax year multiplied by that year's business apportionment factor. For a combined report, the NOL is the combined business loss incurred in a particular tax year multiplied by the combined business apportionment factor for that tax year. The combined business loss amount cannot include any New York investment capital losses.3 A generally non-US corporation calculates its NOL using effectively connected income as a starting point for the business income base.
Additionally, the draft regulations define a "separate return year" as a corporation's tax year for which it filed (1) a separate return or (2) as a member of a different combined group.
Under the draft regulations, the NOLD is not limited to the federal NOLD amount for tax years beginning on or after January 1, 2015, but is determined using the same limitations that apply for federal income tax purposes regarding the NOLs of acquired or merged loss companies. Generally, a corporation's NOLD is allowed in computing its business income base. The corporation's NOLD equals its NOL, from one or more tax years, that is carried forward or carried back to a particular tax year, subject to certain limitations. Likewise, a combined group's NOLD is allowed in computing the combined group's business income base. The combined group's NOLD equals the aggregate amount for combined group purposes, from one or more tax years, that is carried forward or carried back to a particular tax year, subject to certain limitations.
If a corporation were to claim a prior NOL conversion (PNOLC) subtraction5 and a NOLD for a particular tax year, the PNOLC subtraction would be applied against the business income base before the NOLD. In this situation, the corporation must apply the amount of the NOLD that reduces the tax on total business income (after the PNOLC subtraction and before the NOLD) to the higher of the capital base tax or the fixed dollar minimum tax.6 Similarly, for a combined report, the corporation must apply amount of the NOLD that reduces the tax on total business income (after the PNOLC subtraction but before the NOLD) to the higher of the combined capital base tax or the fixed dollar minimum tax of the designated agent.
A corporation that files as part of a consolidated group for federal income tax purposes, but files for Article 9-A purposes either separately or as part of a combined group that differs from its federal consolidated group, would prepare an "as if" federal income tax consolidated return to calculate its NYS NOL and NOLD on either a separate basis or as if it were filing a consolidated federal return with only the NYS combined group members. Additionally, a corporation may not claim a NOLD for any NOL from a New York S year (i.e., a tax year of a New York S corporation),7 any tax year beginning before January 1, 2015, or any tax year in which the corporation was not subject to the Article 9-A tax itself or as a member of a combined group subject to tax under Article 9-A.
Application of NOLs8
Generally, an NOL must be carried back three years before the tax year of the loss (loss year) but may not be carried back to a tax year beginning before January 1, 2015. First, the NOL is carried back to the earliest of the three tax years before the loss year; any remainder is carried back chronologically to the next earliest tax year preceding the loss year, and so on. Unused amounts from exhausted carryback options are carried forward to the tax year immediately following the loss year and then to the next immediately succeeding tax year for up to 20 tax years after the loss year. The earliest NOL incurred would be applied first when a corporation or combined group has two or more NOLs carried back or carried forward to be deducted in one tax year. Additionally, a corporation that files as a member of a new combined group may not carry back its separate-return-year NOL to offset the combined group's income in a tax year in which the corporation was not a member of the combined group. Such an NOL, however, may be used or carried forward to offset income of that combined group in any tax year in which the corporation is a group member.
The draft regulations also describe how to calculate and apply NOLs when a combined group member files a separate report or as a member of a different combined group for a previous or succeeding tax year, as well as how corporations or combined groups can elect to irrevocably waive an NOL's entire carryback period (e.g., on a timely-filed, original return (determined with regard to extensions)).9 For combined groups, the election to waive the carryback requirement is made by the designated agent and applies to all members of the combined group, even those that join the combined group after filing separately or coming from another combined group. If a corporation calculates a higher tax liability for the tax year under the capital base tax or the fixed dollar minimum tax than under the business income base, it would not need to use a NOLD. That year, however, would be treated as a tax year for purposes of determining the number of tax years an NOL could be carried back or forward.
Claiming credits or refunds10
A corporation that claims a franchise tax credit or refund for a tax year to which a NOLD is carried back would file an amended return within the applicable statute of limitations for credits or refunds under N.Y. Tax Law Section 1087. For NOLs that were carried back and subsequently changed, the Tax Department may assess additional tax for a resulting deficiency at any time for the tax year of the loss, in accordance with N.Y. Tax Law Section 1083(c)(4). In addition, the Tax Department may refund an overpayment at any time as permitted by law, whether or not the NOL was affected by a change in business income, the business apportionment factor or both. These rules would apply to all years affected by the revised NOL amount.11
Discharge of indebtedness income12
A corporation that carries an NOL forward to a tax year in which it has discharge-of-indebtedness income that was excluded from federal taxable income would reduce the carryforward in accordance with IRC Section 108(b)(2) and related regulations. The reduction amount would be determined by applying the New York business apportionment factor for the discharge year to the amount of the NOL carryforward that must be reduced.
Carryforwards in certain corporate acquisitions13
The carryforward of any NOL incurred for tax years beginning on or after January 1, 2015, is limited after a reorganization or merger, using the same principles for limiting an NOL carryforward for federal income tax purposes under IRC Sections 381 through 384 and related regulations and any other section of the IRC or related regulations.14 In addition, NOLs arising in tax years beginning on or after January 1, 2015, and carried forward to a combined report from a "separate return limitation year" (SRLY)15 may be used to reduce the combined group's business income only to the extent the combined group attributes income to the corporation that carried the loss forward from the SRLY.16
NOL carryforwards subject to IRC Section 382 must reflect the respective business apportionment factor for each loss year and the proportional limitation in IRC Section 382. The NOLD from the acquired corporation would be limited to the lesser of (1) the IRC Section 382 limitation adjusted for NYS purposes to reflect the applicable period and business apportionment factor or (2) the amount of the apportioned business income of the acquired loss company or companies in the current tax year. If any of these NOLs are from the same loss year as the acquiring corporation's losses, the amount of SRLY-limited carryforward would be applied before applying any other NOL against the combined group's remaining business income.
REMIC excess inclusion17
In accordance with IRC Section 860E(a)(1),18 the total business income in any tax year of any REMIC residual interest holder shall not be less than the excess inclusion (EI) for that tax year. The same rule applies to the total combined business income of a combined group that includes a REMIC residual interest holder. A NOLD would be prohibited in any tax year that total business income equals EI. Under the draft regulations, an NOL may be generated when a corporation's total business income, or total combined business income, is determined by EI. The draft regulations supply a calculation for determining these NYS NOLs.19
The Tax Department states on its website that the draft regulations are not to be relied upon until they are finalized and that it is unclear when they will be final and effective. It is uncertain whether New York City will follow the draft regulations in whole or in part for purposes of its corporate business tax laws.
The draft regulations would repeal and replace existing NYS NOL regulations, which define an NOL and NOLD without regard to IRC Section 172 (NYS tax reform statutory language specifically divorced itself from the federal NOLD under IRC Section 172 and provided its own definitions of an NOL and NOLD20).The draft regulations, however, appear to strictly conform to IRC Sections 381-384 concerning NOL attributes and limitations for corporate carryovers following mergers and acquisitions.21 It thus appears that the draft regulations would decouple from IRC Section 172 without resolving the issue that IRC Sections 381 and 382 reference IRC Section 172 for tax attribute and NOLD limitation purposes. Therefore, taxpayers should carefully review the proposed treatment of NOLs in the context of corporate reorganizations, acquisitions and dispositions.
Moreover, taxpayers should carefully consider the draft regulations for New York State and City tax purposes when preparing current tax filings including estimated taxes; prior tax filings (i.e., identifying potential refunds and liabilities); audits; financial statements (i.e., deferred tax assets); and acquisitions, dispositions and reorganizations.
1 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.8.
2 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.1 (references N.Y. Tax Law Sections 210(1)(a)(ix) and 210-C(4)(d)).
3 Example 1 in draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.8 addresses how to add back New York investment capital losses in computing the business income base and any NOL.
4 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.2 (references N.Y. Tax Law Sections 210 and 210-C).
5 Because these draft regulations apply to NOLs incurred on or after January 1, 2015, they should not apply to the proposed prior NOL (PNOL) rules (see Tax Alert 2018-2552).
6 See Example 2 in draft N.Y. Comp. Codes and Regs. tit. 20, § 3-10.8.
7 The New York S year, however, would be treated as a tax year to determine the number of tax years to which an NOL could be carried forward or back.
8 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.3 (references N.Y. Tax Law Sections 210(1) and 210-C).
9 Related examples in draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.8 include how a separate filer carries back its NOL to previous years (Example 4), how a combined group member computes its share of NOLs sustained in the loss year (Example 5), and how a combined group member computes its share of NOLs and how that share is carried back to previous years (Example 6).
10 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.4.
11 A related example in draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.8 addresses how NOLs are affected by subsequent adjustments to the loss year, as well as the period for assessing deficiencies when an adjusted NOL is carried to other periods (Example 7).
12 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.5.
13 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.6 (references N.Y. Tax Law Section 210-C(4)(d)) (this draft regulation references only the New York statute related to the combined return law in N.Y. Tax Law Section 210-C(4)(d) but applies IRC Sections 381-384).
14 IRC Section 381 (carryovers in certain corporate acquisitions), IRC Section 382 (limitation on NOL carryforwards and certain built-in losses following ownership change), IRC Section 383 (special limitations on certain excess credits, etc.), and IRC Section 384 (limitation on use of preacquisition losses to offset built-in gains) and related regulations.
15 A SRLY is any separate return year of a corporation.
16 Example 8 in draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.8 addresses how the SRLY principles affect the NOL computation.
17 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.7.
18 IRC Section 860E (treatment of income in excess of daily accruals on residual interests).
19 Examples in draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.8 include how a separate taxpayer that is a REMIC residual interest holder computes its NOL in a year that its business loss (Example 9) or business income (Example 11) is limited by EI, and how a combined group with a member that is a REMIC residual interest holder computes its NOL in a year that its business loss is limited by EI (Example 10).
20 N.Y. Tax Law Section 210(1)(a)(ix).
21 Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-10.6.