Leaping the Hurdles to Track State Net Operating Losses (NOLs)
The majority of states differ in their treatment of NOL carrybacks and carryforwards, making it a challenge to fully maximize NOL utilization.
State law regarding net operating losses doesn’t follow federal law and varies from state to state. Consequently, it is difficult for corporations filing in multiple states to manage, plan, and utilize NOLs before they expire, or simply track them by state for compliance and provision purposes. If your corporation files combined or consolidated state returns, the task is even greater as you attempt to track state NOLs by state and by entity.
Hurdle #1. Calculating a State Net Operating Loss
When a corporation incurs a federal net operating loss, the corporation must determine how each state calculates its NOL. The majority of states calculate a state NOL on a post-apportionment basis which requires the state NOL to be determined based on the apportionment percentage in the year the NOL is incurred. A handful of states do not have a state NOL independent of the federal NOL.
For example, Virginia does not have its own NOL. In the year of a federal loss, starting Virginia taxable income includes the federal loss. If Virginia taxable income (after apportionment and allocation) is a loss, the loss is not available for carryforward or carryback. Rather, if a federal NOL is carried back or forward, a taxpayer may file a Virginia NOL carryback or carryforward using the federal NOL and adjusting it for Virginia additions and subtractions from the loss year. This calculation, in essence, determines the amount that may be carried forward or back for the Virginia return.
Similar to Virginia, Maine uses the federal NOL carryback and carryforward amounts, and requires taxpayers to complete various adjustments and recapture calculations (if applicable).
Hurdle #2. Treatment of Federal NOL Carryback/Carryforward
When a corporation carries forward or carries back a federal NOL, a majority of the states require corporations to add back the federal NOL deduction. Other states ignore the federal NOL deduction because the state’s starting point for their tax base is federal taxable income before NOL.
Hurdle #3. State Carryback / Carryforward Rules
- Approximately 29 states do not allow NOL carrybacks.
- Approximately 13 states either allow NOL carrybacks to the same extent that federal law allows, or allow NOLs to be carried back two years.
- Three states allow NOLs to be carried back three years.
- Approximately 26 states allow NOLs to be carried forward fifteen or twenty years.
- Three states allow NOLs to be carried forward either five or seven years.
- Five states allow NOLs to be carried forward either ten or twelve years.
- (NOLs) Eleven states allow NOL carryforwards to the same extent that federal law allows.
Hurdle #4. State Combined / Consolidated Returns
Corporations filing state combined or consolidated returns must understand how NOLs are shared among the members of a combined or consolidated return. Generally, states allow current year NOLs to be shared among group members without limitation.
Note: Kentucky is in the minority, in that it allows NOLs to be utilized by other group members only up to 50% of the other entities’ combined income.
Where the majority of the states differ is in their treatment of NOL carrybacks and carryforwards. In combined return situations, approximately 20 states allow NOL carrybacks and carryforwards to only be shared with group members that were part of the original loss year return. Approximately a dozen states do not allow sharing, and require the NOL carryback or carryforward to only be claimed by the member that incurred the loss. In consolidated return situations, a majority of the states have separate return limitation year (SRLY) rules similar to federal law, which impact a group member’s ability to share NOLs with other members.
For the dozen states that do not allow sharing of NOL carrybacks and carryforwards, taxpayers should compute and track the utilization of NOL carryforwards and carrybacks on a separate entity basis.
For the 20 states allowing NOL carrybacks and carryforwards to be shared with other members of the group, states generally require corporations to track NOLs by entity for cases when new entities enter the group or when entities leave the group.
Hurdle #5. State Transition Rules
Corporations must be aware of a state’s rules when the state changes from a separate return reporting state to a combined return reporting state.
For example, for years prior to 2009, Wisconsin only allowed separate reporting. Under Wisconsin’s combined reporting regime, Wisconsin allows current year losses to be combined and utilized by all members of the group. However, the sharing of NOL carryforwards is limited. For tax years beginning before 2012, Wisconsin does not allow members of a combined group to share NOL carryforwards that were created in taxable years before January 1, 2009. After 2011, each combined return member with pre-2009 NOLs may apply the NOL carryforward to its own income, and then if any NOL carryforward is left, the entity may apply 5% of the NOL carryforward to other members of the group. This utilization method may be used for a total of 20 years until the pre-2009 NOL carryforward is fully spent or expired.
Another example is Rhode Island which adopted combined reporting in 2015. Rhode Island does not allow pre-2015 NOL carryforwards to be shared among members of a combined return.
Hurdle #6. State Suspension and Limitations
States often enact suspension periods or limitations on the amount of NOLs allowed to be carried back or carried forward during tax years when the economy slows or the state is having budget difficulties.
For example, California enacted several NOL limitations during 1999 to 2003 and again in 2013 and 2014. For NOLs incurred in a taxable year beginning on or after January 1, 2013 and before January 1, 2014, the carryback amount cannot exceed 50% of the NOL. For tax years beginning on or after January 1, 2014, the carryback amount cannot exceed 75% of the NOL. California also enacted a suspension period, disallowing a NOL deduction entirely for tax years beginning on or after January 1, 2008 and before January 1, 2012. Illinois limited a NOL carryover deduction to $100,000 per taxable year for tax years ending after December 31, 2012 and prior to December 31, 2014. Illinois also suspended the utilization of NOL deductions for tax years ending after January 1, 2011 and prior to December 31, 2012.
Leaping the Hurdles
In response to the complexity surrounding the calculation and tracking of state NOLs, corporations must implement tools and processes to not only meet compliance and provision demands, but to also maximize NOL utilization.
State Tax Analyzer™, from Bloomberg Tax, lets you handle even the most demanding tax planning and provision situations. You can efficiently create base scenarios from as-filed returns and copy them to new scenarios and projects, to support tax audit, provision, and planning needs. Calculations across all states and the District of Columbia that have corporate income taxes are all handled automatically, with far greater efficiency and peace of mind than using spreadsheets.