Turbulent economy affects states' treatment of NOL carryovers

By Jeffrey Cohen, CPA
Stout, Causey & Horning, P.A.

Due to the country's turbulent economy over the past few years, more companies are realizing net operating losses (NOLs) than ever before.

In an effort to jumpstart the economy, the government has passed various tax laws that attempt to help businesses utilize their assets and improve their cash flow.

Under the Job Creation and Workers Assistance Act of 2002, NOLs generated during 2001 and 2002 may be carried back up to five years in order to obtain tax refunds, versus two years under the original law. The new law created a tax planning opportunity for the use of NOLs. Many businesses were able to take advantage of this new law to file amended income tax returns in an effort to obtain refunds and improve operating cash flow.

We are all aware, however, of the increasing difficulties many state governments are having with balancing their budgets. This has caused many states to look for ways to increase their own cash flow. In some cases, this has resulted in tax increases; in others, more subtle methods have been employed.

An area that many states looked to was the NOL refund opportunity presented by the Job Creation and Workers Assistance Act of 2002.

All states have their own rules regarding NOLs and the ability to carry them back to previous years or carry them forward to future years. Many states decoupled themselves from the new federal law and will not allow taxpayers to carryback more than the original two years. The new decoupling employed by many states further complicates these rules and makes tax planning for the use of NOLs an even greater necessity.

Let's take a look at some of the states and their specific rules regarding NOL carrybacks and carryovers.

Maryland: Generally, Maryland follows the federal tax law. However, Maryland decoupled from the Job Creation and Worker Assistance Act (P.L. 107-147). Net operating losses in Maryland may be carried back only two years but may be carried forward 20 years (Sec. 10-108 amended by Ch. 440 (S.B. 323), Laws 2002).
California: California has its own set of rules related to NOLs. Prior to Jan. 1, 2000, no NOL carryback was allowed in California and only 50 percent was allowed to be carried forward for a five-year period.

California recently passed new legislation regarding NOL treatment. The 50 percent carryforward rule will gradually increase until it reaches 100 percent for tax years beginning after 2003. For income years beginning on or after Jan. 1, 2000, the carryforward period has been extended to 10 years (CA Code 24416). The net operating loss deduction is now suspended for taxable years 2002 and 2003. However, the net operating loss carryover period for these loss years is extended by one year for losses incurred during 2002, and by two years for losses incurred before Jan.1, 2002 (CA Code 24416.3).
Delaware: Generally, Delaware follows the federal law except that any deduction exceeding $30,000 for a net operating loss carryback under IRC Sec. 172 must be subtracted from federal taxable income. The taxpayer may increase deductions in any year to carry forward losses that were carried back for federal income tax purposes, but that do not exceed $30,000 (Sec. 1903(a)(8)).
New Jersey: Like California, New Jersey has its own set of rules related to NOLs. New Jersey does not allow an NOL carryback and the carryforward period is limited to seven years (New Jersey Regulation, Reg. 18:7-5.13). The Business Tax Reform Act of 2002 disallowed the deduction for net operating loss carryover for privilege periods beginning during calendar years 2002 and 2003, but extended the seven-year carryforward by two years.
New York: Generally, New York follows the federal NOL rules. New York allows a modified and apportioned net operating loss, which is generally the same as the federal NOL, except that the carryback is limited to the first $10,000 of loss in any taxable year. Due to the federal Job Creation and Worker Assistance Act, the carryback period is five years for losses arising in 2001 and 2002 and remains 20 years carried forward ([Sec. 208(9)(f)][Reg. 3-8.1]).
Pennsylvania: Pennsylvania does not allow an NOL carryback. For tax years after 1997, losses may be carried forward for 20 years from the original period of 10 (Act 45, Laws 1998, 100-681a).
Virginia: Generally, Virginia follows the federal NOL rules. However, Virginia does not conform with the five-year carryback enacted by the federal Job Creation and Worker Assistance Act and allows only a two-year carryback and a 20-year carryforward period (Ch. 2 (H.B. 2455), Laws 2003).

It is clear that the state governments' attempt to deal with their budget shortfalls is creating a ripple effect on corporate America. Now more than ever, companies need to be aware of state laws and understand that good tax planning is a must in order to minimize the amount of taxes that they pay.

Editor's note: Jeffrey Cohen, CPA, is a senior in the income tax department of Stout, Causey & Horning, P.A. He provides multi-state tax consulting services to his middle-market clients and assists them with federal, state and local tax compliance issues.

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