Conformity Issues in SALT

Transcription

1 Carley Roberts, Partner Zachary Atkins, Associate TEI Nashville 2014 Spring Seminar Franklin, TN May 14, 2014 Conformity Issues in SALT

2 Agenda Conformity and the State Income Tax Base Capital Gains Conformity Issues Net Operating Losses Tax Free Reorganizations Dividends 2

3 Conformity and the State Income Tax Base 3

4 Conformity Types of conformity Static Moving Specific conformity Scope of conformity Federal regulations, rulings, case law Federal consolidated return regulations Treaties and treaty exemptions 4

5 State Income Tax Base Federal Taxable Income (Line 28 or 30) + Addition Modifications - Subtraction Modifications State Tax Base - Non-business Income (total) Business income * Apportionment Percentage Apportioned Business Income + Non-business Income (to this state) State Taxable Income 5

6 Common Addition Modifications Income taxes Federally tax exempt interest Dividends received deductions Gains and losses Depreciation Net operating loss deductions Interest expense 6

7 Common Subtraction Modifications State tax refunds Interest on U.S. obligations State dividends received deductions Foreign source income, foreign dividends, FSC dividends Gains and losses Dividends paid deduction (e.g. REITs) 7

8 Federal Capital Gains Treatment Tax Reform Act of Capital gains now taxed at ordinary income tax rate Limitations Carryover three years back and five years forward (IRC 1212) Matching capital loss limited to capital gains (IRC 1211) Corporation would prefer capital gain income and ordinary loss deduction Capital gains taxed once and not on annual basis Ordinary loss deduction can give rise to net operating loss 8

9 State Conformity to Federal Capital Gains Treatment Prior to the federal elimination of preferential treatment, few states allowed preferential rates State tax rates already much lower than federal tax rates Constitutional limitations on favoring in-state investments Following federal elimination of the preferential rate, no state provides preferential treatment Some states, however, provide favorable treatment on certain assets NY excludes gain realized from subsidiary stock DE excludes gain from U.S. and DE issued securities 9

10 State Conformity to Federal Capital Gains Treatment Matching income the majority of states follow the federal rule that capital losses are deductible only to the extent of capital gains MI, NC, OR, and TN permit the offset of capital losses against ordinary income Carryover limitations The majority of states conform to the federal carryforward rule Some states disallow capital loss carrybacks AR, CA, CT, FL, HI, MA, MD, MN, MT, NC, NE, SC, TN Several states disallow carryovers, both forward and back AR, MA, MT, NC, TN 10

11 Why retain limitations on capital gains and losses? Carryover rules as remnant plan to bring back preferential rates? Tax Reform Act of 1986 also equalized rates on capital gains and ordinary income for individual taxpayers Congress has since reinstituted preferential rates on capital gains for individuals But states lack the need/incentive for preferential rate Constitutional limitations on favoring in-state investments US policy of preferential rate for capital gains treatment cannot apply at state level State rates are already much lower than federal rates 11

12 Allocating and Apportioning Capital Gains and Losses General Electric v. Iowa State Bd. of Tax Review, 702 N.W.2d 485 (Iowa 2005) GE had a capital gain ($577m) in 1993, which it reported on its federal and Iowa returns. Income was nonbusiness and allocable to commercial domicile in NY, so GE deducted it from Iowa income as allocable income. In 1995, GE had a capital loss and carried back $577m to 1993, even though gain in 1993 was allocated outside IA. The Department argued that GE needed to reduce its nonbusiness income by the amount of the capital loss carryback. GE argued that the $557m must be allocated outside Iowa, even though the amount was already deducted by adopting federal taxable income as the starting point. Iowa S. Ct. agreed with the Department and held that GE had to reduce its 1993 nonbusiness income by $557m because it was not included in the Iowa tax base Can only apportion or allocate income that is included in the starting point for the state s taxable income Avoiding windfall/double deduction to corporation 12

13 Constitutional Limitations on Favoring In-State Investments Cutler v. Franchise Tax Board, 146 Cal. Rptr. 3d 244 (Ct. App. 2012) California provided a capital gain deferral scheme, under which a taxpayer could defer its capital gain from the sale of stock of a qualified small business if the taxpayer subsequently invested in another California-based qualified small business within sixty days. California Court of Appeal held that the scheme violated the Commerce Clause Though California allows for a deferral of the tax and not an outright exemption, the deferral scheme was discriminatory Favors in-state investments over out-of-state investments CA FTB Notice In response to Cutler, the FTB issued a notice stating that it would retroactively collect the tax from taxpayer s who previously fell within the exception, unless the tax period fell outside the four year statute of limitations 13

14 Net Operating Losses 14

15 NOL Calculation Issues Pre- or post-apportionment? Which year s factor? State specific modifications/limitations Addition modifications in C/B or C/F year (MD, MO, OK) Limits (PA increased cap from $2m to greater of $3m or 12.5% of taxable income eff. Dec. 31, 2006, greater of $3m or 15% of taxable income eff. after 2008, and greater of $3m or 20% of taxable income eff. after 2009) Net economic losses (NC) Blind conformity to federal utilization Effect of state filing methodology Is nexus required in loss year? 15

16 Conformity: Using a State s NOL Rules Two approaches to utilizing a state s NOL rules 1. Start with Line 28 and determine the NOL using the state rules a) E.g. AZ, DE, FL, GA, MI, NY, PA, TN 2. Start with Line 30, add back the federal NOL, and compute using the state rules a) E.g. IN, IA, NC, VT Some states that calculate the NOL using their own rules, nevertheless, may limit the NOL to the amount of the federal NOL E.g. Colo. Rev. Stat Starts at line 30, adds back federal NOL, but states that the amount of carryover allowed shall be portion of the federal NOL allocated to Colorado 16

17 Using the Federal NOL Deduction States using the federal NOL start with Line 30 State additions and subtractions made to determine the modified federal tax base Divide modified federal tax base among the states according to the state s apportionment provisions Ties state NOL deduction to the existence of a federal NOL deduction May impose requirement that the state NOL, determined after state additions and modifications, cannot exceed the federal NOL 17

18 State to Conformity to Carryover of NOLs All states provide for carryover of NOLs Many states do not provide for carryback of losses Waiver States conform by reference to incorporation of IRC 172 E.g. Maryland requires proof of federal waiver (Md. Code Ann. Tax-Gen ) But see Montana Notice Montana Department of Revenue amended its regulations to provided that waiving NOL carryback for federal purposes does not automatically waive carryback for state purposes 18

19 Pre- or Post-Apportionment? Pre-apportionment: NOL deduction taken before allocation and apportionment E.g., NY, MA, MO, NJ, TN, VA Post-apportionment: States require that NOL be carried back or forward after allocation or apportionment NOL deduction taken in carryback or carryforward year after allocation and apportionment More accurate reflection of losses attributable to the state E.g., CA, IL, OH, TX, PA 19

20 Net Operating Loss Carryovers The states often have special rules for net operating loss carryovers (NOLs) that do not track the federal rules. Taxpayers should not assume that NOLs that are available for federal tax purposes will be available for state tax purposes. 20

21 Net Operating Loss Carryovers States often have shorter carryforward periods than the federal 20-year period. NOLs that are still available for federal tax purposes may have expired in one or more states. NOLs may be suspended, sometimes for state budgetary reasons. Some states allow NOLs only to the extent that they are attributable to in-state activities. Use of NOLs may vary if state combined group is different from federal consolidated group. Apportionment of NOLs may vary, affecting availability of NOLs in different states. 21

22 Net Operating Loss Carryovers Some states do not have a provision allowing NOLs or unused credits to move from the target corporation to the buyer in a tax-free reorganization comparable to IRC section 381. In those states, the NOLs may be extinguished in the transaction. Case law in some states has held that the target s NOLs nevertheless survive the transaction if the buyer after the transaction continues the target s business that generated the NOLs, See, e.g., Oliver s Laundry & Dry Cleaning Co. v. Ariz. State Tax Comm., 19 Ariz. App. 442, 508 P2d 107 (1973); Thermatool Corp. v. Dep t of Rev. Services, 43 Conn. Sup 260, 651 A2d 763 (1994). WARNING: This is a potential problem when a corporation with NOLs is reincorporated in another state by merging into a new shell corporation. Idaho statute: NOL passes in a merger but not in a C reorganization or in a section 332 liquidation. 22

23 Federal Consolidation and SRLY Rules A federal consolidated group computes its net operating loss on a group basis However, federal consolidation principles limit the use of NOLs by the consolidated group when generated by a member in a separate return year 23

24 SRLY Requirements If a NOL in a separate return year arose during a year when the corporation was a member of the affiliated group and could have joined in a consolidated return, then The group can use the loss If the loss arose during a year in which the corporation was not a member of the affiliated group, then Use of NOLs generated by a member in a separate return year limited to the extent of that member s taxable income in the group in the carryover year Cannot use to offset income of other members 24

25 Effect of State Filing Methodology Some, but not all, states follow federal consolidation principles (e.g. 1502) E.g. Alabama follows federal SRLY rules (Ala. Code ) Computation performed at the unitary group or separate member level Illinois NOL computation follows group theory California NOL computation follows separate company theory 25

26 Effect of State Filing Methodology (cont d) State approaches vary as to computing NOLs and, in some instances, state NOLs may differ from the NOL of a federal consolidated group Some combined return states require that NOLs be tracked on a separate company basis Some states incorporate limitations similar to SRLY 26

27 Effect of State Filing Methodology (cont d) Coca-Cola Enterprises Inc. v. Ala. Dep t of Revenue, No. Corp (Ala. Dep t of Rev. Feb.14, 2013) Alabama ALJ held that an affiliated group can deduct NOLs from years when the group did not file an Alabama consolidated return. However, the corporation that incurred the loss must have been a member of the group at the time the loss arose. Group must meet definition of affiliated group at the time the loss arose Thus, an affiliated group can exist before it elects to file an Alabama consolidated return 27

28 Tax-free Reorganizations State income taxes generally conform to the federal reorganization provisions and a transaction that is a tax-free reorganization under IRC section 368 will be tax-free for state income tax purposes. WARNING A transaction that is not subject to federal, state, and local income taxes may be subject to state and local gross receipts, sales, and real property transfer taxes. 28

29 Spin-offs The distribution of the stock of a subsidiary corporation will generally be tax-free to the distributing parent and the parent s shareholders if the corporations are each engaged in an active business, there is a non-tax business purpose for the distribution, and the distribution is not a device to distribute the parent s earnings and profits. IRC section 355. The states generally follow the federal treatment of spinoffs. A spin-off that qualifies under section 355 will generally be tax-free for state income tax purposes. 29

30 Spin-offs - Areas of Nonconformity with Federal Rules Mississippi taxes the distributing parent corporation (but not its shareholders) on any gain on the subsidiary s stock. Regs. section 801(f). New Hampshire does not follow the federal rule that qualification under the active business test is determined on an affiliated group (and not a separate corporation) basis because it conforms to the Internal Revenue Code as in effect before the effective date of IRC section 355(b)(3). California conformity to section 355(b)(3) ended on November 3, Holding company rule still applies. 30

31 Dividends 31

32 Dividends In general, broad conformity with federal DRD However, REIT dividends currently being targeted (often labeled as loopholes ) Distributions from non-u.s. affiliates frequently an issue 32

33 Addback of Dividends Received Deductions Mississippi Dep t of Revenue v. AT&T Corporation, 101 So. 3d 1139 (Miss. 2012) Mississippi s filing scheme allows corporations to file as a consolidated group, as opposed to filing on a combined basis, if all members of the affiliated group do business solely within the state. AT&T filed on a consolidated basis to challenge the statute, and the Department changed AT&T s filing method to combined, and added back all dividends received deductions of members not doing business in the state. AT&T challenged the statute as a violation of the Commerce Clause, and the Chancery Court found in its favor. However, the Mississippi Supreme Court reversed on procedural grounds, finding that the Chancery Court lacked appellate jurisdiction because AT&T paid the assessment under protest, rather than filing a petition accompanied by a bond. 33

34 Tax Base - REITs Forced combination NY requires forced combination of REIT with unitary group (S. 2110, 4/1/2007) Denial of deduction for payments to captive REITs MD Press Release Comptroller s Office (Mar. 2007) (legislation was enacted thereafter) Fleet Funding Inc. & Fleet Funding II Inc. (Mass. App. Tax Bd. Feb. 21, 2008) Wal-Mart, North Carolina (January 4, 2008) 34

35 Tax Base - REITs Utah: H.B. 359, and Oklahoma effective for taxable years beginning on or after January 1, West Virginia, effective for tax years beginning on or after January 1, 2009 Denial of DRD Arizona DOR Director s Decision (9/15/2006) Massachusetts BankBoston (Mass. App. Ct. 2007) New Jersey Effective for distributions paid on or after February 6,

36 Questions? Carley Roberts Zachary Atkins

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