The federal stimulus bill (the CARES Act), HR 748, which was signed into law by President Trump on March 27, includes certain corporate income tax provisions designed to provide relief to corporate taxpayers. One such provision–the net operating loss (NOL) provision that allows taxpayers to carryback NOLs to prior years–could have unintended consequences at the state level. For some taxpayers, the carryback of NOLs to 2018 and 2019 could reduce the deductions allowed pursuant to IRC § 250 applicable to global intangible low-taxed income (GILTI) and foreign derived intangible income (FDII) generated in those years. While this will obviously have federal income tax consequences it will also have consequences in states that tax GILTI and allow the deductions in IRC § 250. This blog post focuses on the consequences of the NOL rules to the New Jersey Corporation Business Tax (CBT), but the issue could arise in other states, including, for example, Nebraska and Iowa.
The New York Legislature has passed bills related to the 2015–2016 budget (S2009-B/A3009-B and S4610-A/A6721-A, collectively referred to herein as the Budget Bill) containing several significant “technical corrections” to the New York State corporate income tax reform enacted in 2014, along with sales tax provisions and amendments to reform New York City’s General Corporation Tax. The Budget Bill’s technical corrections to last year’s corporate income tax reform include changes to the economic nexus, tax base and income classification, tax rate (including clarifications to rules applicable to certain taxpayers, such as qualified New York manufacturers), apportionment, combined reporting, net operating loss and tax credit provisions. The technical corrections are effective on the same date as last year’s corporate income tax reform, which was generally effective for tax years beginning on or after January 1, 2015.
This post is the sixth in a series analyzing the New York Budget Bill, and discusses changes to the net operating loss (NOL) and investment tax credit provisions.
Net Operating Losses – Prior NOL Conversion Subtraction
For tax years beginning on or after January 1, 2015, the calculation of the New York NOL deduction has changed dramatically. As a result, the Tax Law provides for a transition calculation, a prior NOL Conversion Subtraction, for purposes of computing the allowable deduction for NOLs incurred under the prior law.
To calculate the Conversion Subtraction, the taxpayer first must determine the amount of NOL carryforwards it would have had available for carryover on the last day of the “base year”—December 31, 2014, for calendar year filers, or the last day of the taxpayer’s last taxable year before it is subject to the new law—using the former (i.e., 2014) Tax Law, including all limitations applicable under the former law. This amount is referred to as the “unabsorbed NOL.” Second, the taxpayer must determine its apportionment percentage (i.e., its BAP) for that base year (base year BAP), again using the former (i.e., 2014) Tax Law; this is the BAP reported on the taxpayer’s tax report for the base year. Third, the taxpayer must multiply the amount of its unabsorbed NOL by its base year BAP, then multiply that amount by the tax rate that would have applied to the taxpayer in the base year (base year tax rate). The resulting amount is divided by 6.5 percent (qualified New York manufacturers use 5.7 percent). The result of these computations is the prior NOL Conversion Subtraction pool.
A taxpayer’s Conversion Subtraction will equal a portion of its Conversion Subtraction pool computed as outlined above. The standard rule provides that one-tenth of the Conversion Subtraction pool, plus, in subsequent years, any amount of unused Conversion Subtraction from prior years, may be deducted as the Conversion Subtraction. The Tax Law as originally drafted also provided that any unused Conversion Subtraction could be carried forward until tax years beginning on or after January 1, 2036 (tax year 2035 for calendar year filers). The technical corrections include slight changes to that carryforward provision. Now, any unused Conversion [...]
A New York State Division of Tax Appeals administrative law judge (ALJ) recently determined that a banking corporation was not required to hypothetically use a net operating loss (NOL) deduction to decrease its entire net income in a year in which its banking corporation franchise tax liability under Article 32 of the New York Tax Law (bank tax) was not measured by the entire net income base. Matter of TD Holdings II, Inc., DTA No. 825329 (N.Y. Div. Tax App. Jan. 22, 2015). This case is a sterling example of how long-held and long-applied state tax audit policies can be successfully challenged. Taxpayers – in several states at least – can rely on the state’s adjudicatory process to ensure that logical results that are consistent with legislative intent are ultimately applied. McDermott represented the taxpayer in this case.
Though the bank tax has been repealed effective January 1, 2015, during the years at issue, the tax was imposed on one of four alternate bases, whichever resulted in the highest tax:
- A tax on entire net income;
- A tax on taxable assets;
- A tax on alternative entire net income; or
- A minimum tax.
Note that New York’s current general business franchise tax is similarly imposed on a number of alternative bases, and that banking corporations are now subject to that tax. See N.Y. Tax Law § 210.
In the case at issue, TD Holdings II, Inc., and certain of its disregarded subsidiaries (collectively, TD) had approximately $9 million of New York NOLs available to carry forward to its 2006 tax year. However, for 2006, TD’s bank tax liability on its asset base was greater than its bank tax liability computed using its entire net income base—even without application of an NOL deduction. Therefore, because TD was not required to pay tax based on the income base, it argued that it should not have to hypothetically use any portion of its available New York NOLs to reduce its entire net income base in the 2006 tax year, thereby reducing its New York NOLs available for carry forward to later years.
The Division of Taxation, arguing that because the Tax Law provided that a corporation’s New York NOL deduction in a given tax year is “presumably the same as” its federal NOL deduction for that same year, asserted that TD had to take a New York NOL deduction in 2006 that equaled its federal NOL deduction despite the fact that TD was not required to pay bank tax on the income base.
The ALJ agreed with TD, holding that TD “was not required by the plain language of the statute to hypothetically apply [its] New York NOL to an entire net income that was already sufficiently low enough to cause the use of an alternative tax base,” and that there is no statutory prohibition against a taxpayer using a New York NOL deduction that is less than its corresponding federal deduction notwithstanding statutory language that prevents a taxpayer from taking [...]
Earlier this year, New York enacted sweeping corporate tax reform that included a number of special benefits for qualified New York manufacturers. (For a discussion of this corporate tax reform, see our Special Report.) Unlike most of the corporate tax reform amendments (which are generally effective for tax years beginning on or after January 1, 2015), some of the benefits for qualified New York manufacturers are effective immediately for tax years beginning on or after January 1, 2014.
The new benefits available to qualified New York manufacturers are:
- A 0 percent tax rate for purposes of computing tax on the entire net income base (for 2014) or the business income base (for 2015 and later);
- New reduced tax rates for purposes of computing tax on the capital base (with the capital base tax to be fully phased out for all taxpayers by 2021)
- Retention of the $350,000 cap on the capital base tax (while the cap was increased to $5 million for other taxpayers);
- Lower fixed dollar minimum tax rates; and
- A refundable real property tax credit equal to 20 percent of the real property tax paid during the taxable year on property owned (and in some cases leased) by the taxpayer and principally used in manufacturing.
A corporation or a combined group is a “qualified New York manufacturer” if (1) more than 50 percent of the taxpayer’s or combined group’s gross receipts are from qualifying activities (e.g., manufacturing, processing or assembling) and (2) it has property meeting the Investment Tax Credit (ITC) requirements located in New York State with a basis of at least $1 million. A taxpayer, or combined group, that fails the receipts test may still be a qualified New York manufacturer if it has at least 2,500 New York manufacturing employees and at least $100 million of manufacturing property in New York.
Notwithstanding these tax benefits, the Department’s recently released FAQs highlight a potential negative financial statement consequence for taxpayers with significant deferred tax assets, including New York net operating loss carryforwards. In the FAQs, the Department confirms that the value of the prior net operation loss conversion subtraction for a qualified New York manufacturer “is $0 due to the 0 % ENI rate.” In other words, a qualified New York manufacturer cannot carry forward or use its existing net operating loss carryforwards in future years, which may result in negative financial statement consequences.
Qualified New York manufacturers with significant New York credit carryforwards may also suffer a financial statement impact, but the forecast is not as bleak. They may still have the ability to apply most unused credits against the capital base tax (until it is fully phased out).
Stay tuned for additional guidance regarding qualified New York manufacturers. The Department is preparing a technical memorandum regarding qualified New York manufacturers that is expected to be released by the end of this year.
Earlier this year, New York enacted sweeping corporate tax reform, generally effective for tax years beginning on or after January 1, 2015, including a new economic nexus standard, changes to New York’s combined reporting regime, changes to the tax base and traditional New York income classifications, changes to the receipts factor computation, and changes to the net operating loss calculation and certain tax credits and incentives. (For a more detailed discussion of these changes, see our Special Report.
While this corporate reform is quite comprehensive, a number of open issues remain so taxpayers and practitioners have been eagerly awaiting additional guidance from the Department of Taxation and Finance. As a first step in providing that much-needed guidance, the Department has released its first set of responses to frequently asked questions on a new “Corporate Tax Reform FAQs” section of its website. Most notably, the responses clarify that the non-unitary presumption based on less than 20 percent stock ownership for purposes of determining exempt investment income is a rebuttable presumption. The responses also clarify that the business capital base includes items of capital that generate exempt income. Other topics addressed include economic nexus, credits, the Metropolitan Transportation Business Tax (MTA surcharge) and net operating losses.
The Department plans to update the Corporate Tax Reform FAQs on an ongoing basis as it continues to receive questions from taxpayers and practitioners, which can be submitted on the Department’s website. We will be submitting questions and comments and can do so on behalf of companies that do not want to be identified. The Department is also in the process of revising its current regulations (which are expected to be released before the end of 2015) and plans to issue two technical memoranda in the interim, one discussing qualified New York manufacturers and one discussing the new expense attribution rules. Stay tuned for updates regarding this additional guidance.
The corporate tax reform portion of the New York State 2014–15 Budget Bill resulted in major changes for virtually all corporations—even many that are not currently New York taxpayers. In this video (produced by SmartPros), McDermott partners Arthur Rosen, Maria Eberle, Lindsay LaCava and Leah Robinson will discuss the implications of New York State’s sweeping corporate tax reform, including changes to the Article 9-A traditional nexus standards, the combined reporting provisions, the composition of the tax bases and computation of tax, the apportionment provisions and the net operating loss calculation.
For more information on these issues, please click here for our Special Report, “Inside the New York Budget Bill: Corporate Tax Reform Enacted.”