United States: ALJ: New York NOL Deduction Does Not Apply When Tax Is Not Paid On Income Base

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Though the bank tax has been repealed effective January 1, 2015, during the years at issue, the tax was imposed on one of four alternate bases, whichever resulted in the highest tax: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 a New York NOL deduction that exceeds its federal deduction.  The ALJ also agreed with TD's application of the legislative history and policy behind New York's NOL deduction, which is "to ensure that taxpayers with fluctuating earnings would not be punished compared to those with steady earnings."  TD argued and the ALJ agreed that to accomplish the legislature's goal of allowing a taxpayer to offset its high tax liability in profitable years with losses incurred in unprofitable years, "the applicability of a NOL deduction must be tied to a taxpayer's income."  The ALJ concluded that because "income" was not used as a basis for computing TD's bank tax, it was unnecessary for TD to claim a hypothetical New York NOL deduction in the 2006 tax year.

ALJ determinations are non-precedential; however, by expressly providing that the maximum amount of NOL that can be carried over and deducted in a taxable year is the amount that reduces the taxpayer's tax on allocated business income (the former entire net income base) to the higher of the tax on capital or the fixed dollar minimum, the TD Holdings II decision is important for taxpayers to consider when computing the pool from which their "prior NOL conversion subtraction" will be computed.  Under the new law, taxpayers are afforded a "prior NOL conversion subtraction" for NOLs generated in tax years beginning before January 1, 2015.  As a result of the TD Holdings II case, taxpayers subject to the bank tax or the corporation franchise tax imposed under Article 9-A for tax years beginning before January 1, 2015, may have a larger pool of pre-reform NOLs from which to compute their prior NOL conversion subtraction.

For more detailed information see McDermott Will & Emery's On the Subject regarding this case.

ALJ: New York NOL Deduction Does Not Apply When Tax Is Not Paid On Income Base

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