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New York simplified the rules for claiming net operating loss (NOL) deductions for all but S corporations as part of its sweeping 2015 overhaul to the General Corporation Tax. In this article, Alysse McLoughlin of McDermott Will & Emery discusses the implication of the recent Matter of Plasmanet, Inc. decision at the New York City Tax Appeals Tribunal, which applied the “same source” rule to limit NOL deductions in New York City. McLoughlin contrasts a 2016 case involving the franchise tax on banking corporations that she says would lead to wasted NOLs, rather than allowing a deferral under the same source rule, as construed in Plasmanet.
By Alysse McLoughlin
Alysse McLoughlin is a partner in McDermott Will & Emery's state and local tax practice.
The New York City Tax Appeals Tribunal just issued a new determination concerning the correct computation of the New York City General Corporation Tax (“GCT”) NOL deduction in years prior to the recent plenary corporate tax reform. Matter of Plasmanet, Inc., TAT(E) 12-17(GC), January 20, 2017. Unsurprisingly, the City Tribunal determined that the “same source” rule (described below) did apply in determining the amount of a taxpayer's NOL that could be used in any year for GCT purposes. While the ultimate determination is not surprising, this case indicates the complexity of complying with New York City's former, for the most part, NOL rules. These rules were changed and simplified for most corporations when New York State and City enacted tax reform, effective in 2015; however, S corporations are still subject to the unchanged net operating loss rules in New York City as the tax reform rules were not extended to such corporations.
The New York City Administrative Code allows a corporation that is subject to the GCT to use a NOL deduction in determining its entire net income. NYC Admin. Code §11-602.8(f). Prior to tax reform, New York State also allowed a corporate taxpayer to use an NOL deduction that was computed in virtually the same manner as the City NOL in all material respects.
In computing the amount of the NOL deduction that the corporation was entitled to use in any year for New York purposes, there are several limitations that had to be followed, including that the NOL deduction in any one year could not exceed the NOL deduction used for federal purposes for that same year. Additionally, although not explicit in the statute, this language that the New York NOL could not exceed the federal NOL has long been held for New York State tax purposes to require that the NOL deduction used for New York State purposes must be composed of the NOLs from the same carryover years that comprise the NOL for federal income tax purposes. Thus, due to the materially similar language used with respect to New York City's NOLs, it was not surprising that the Tribunal in Plasmanet confirmed that this rule applied for City GCT purposes. (Due to conformity with federal law, the Tribunal did allow the taxpayer in Plasmanet to increase the amount of net operating losses available to be carried over to and used in certain years by the amount of charitable deductions that were reported, but were not available for use, for federal tax purposes due to certain ordering limitations. Application of those ordering limitations based on the taxpayer's New York City income resulted in those charitable deductions increasing the amount of the federal net operating loss available for the taxpayer to use during the years at issue. Federal conformity logically mandated such treatment.)
The legislative purpose of a NOL is to even out the gains and losses of a business due to the recognition that imposing tax based on income on a year by year is inherently arbitrary and may not result in a fair representation of the business' income. As noted by the US Supreme Court, NOL carryovers “ameliorate the unduly drastic consequences of taxing income strictly on annual basis. They were designed to permit a taxpayer to offset its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year.” Libson Shops, Inc. v. Koehler, 353 U.S. 382, 386 (1957).
While application of the same source-year rule does not seem completely consistent with this policy, for the most part this rule does not result in loss of a NOL; instead, as in Plasmanet, the rule usually results in deferral of use of the NOL to a later year. This is drastically different from the New York State Tax Appeals Tribunal's decision in TD Holdings II, Inc., DTA No. 825329 (NYS Tax App. Trib., April 7, 2016). In that case, the State Tribunal determined that for the New York State Franchise Tax on Banking Corporations, available NOLs always had to be utilized to reduce the taxpayer's entire net income to zero, even if the taxpayer ultimately paid tax on an alternative basis, such as its taxable assets, and thus received absolutely no benefit from the reduction. This results in a wasting of the NOL in every year that the taxpayer has an NOL available for use in New York, but pays tax on an alternative base. Such a result completely contradicts the policy behind preservation and use of NOLs to offset income generated in different years. Furthermore, federal conformity should not apply in a situation like the TD Holdings case since the federal structure is not similar to the New York State and City corporate income taxes; there is no alternative tax base for federal income tax purposes and thus the issue of the “wasting” of the net operating loss is not pertinent for federal purposes.
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