State and federal NOL rules differ in key respects.

• Author: Nakamura, Karen
• Position: Net operating loss

State net operating loss (NOL) rules generally differ from federal NOL rules, and state NOL rules often differ from one another. This lack of consistency can lead to confusion about a taxpayer's ability to utilize NOLs.

Federal NOL Regime

Sec. 172(b)(1)(A) allows taxpayers to carry NOLs back 2 and forward 20 years, unless a taxpayer elects to waive the carryback period, in which case NOLs will only be carried forward. Legislation enacted in 2009 allows most corporate taxpayers to elect to carry back 2008 or 2009 NOLs up to five years and provides a five-year carryback for 2008 NOLs generated by eligible small business taxpayers.

State NOL Regime

The computation of state taxable income generally begins with either federal taxable income before NOL and special deductions (from line 28, Form 1120, U.S. Corporation Income Tax Return) or federal taxable income after NOL and special deductions (from line 30, Form 1120). The applicable federal starting point is modified to reflect certain addition and subtraction adjustments, such as the addback of expenses not deductible and the subtraction of income not taxable at the state level. Taxpayers should consider a number of common NOL variations.

In general, states require a taxpayer to have nexus (i.e., be subject to tax) in the state in the year a loss is generated in order to carry over a loss to a subsequent tax year. While most states utilize loss year apportionment limitations as a way to require nexus in a loss year, other states generally provide that a taxpayer must have nexus in a loss year to claim an NOL carryover. For example, Maryland regulations provide that a taxpayer cannot use an NOL generated when a corporation is not subject to Maryland income tax law as a deduction to offset Maryland income (MD Code Regs. [section]03.04.03.07(A)(5)). A similar rule applies in Rhode Island (RI Gen. Laws [section]44-11-11(b)).

New York law takes the "subject to tax" restriction one step further and provides that a taxpayer must be subject to the same article of the New York tax law in both the loss year and the carryover year to claim an NOL deduction (see, e.g., NY Tax Law [section]208(9)(f)(2)). Accordingly, if a taxpayer is subject to the Article 32 bank franchise tax based on income in the year an NOL is generated and the Article 9-A corporate franchise tax on income in the year it seeks to claim an NOL carryover, no deduction is permitted. In contrast, Virginia, which does not have its own NOL...