SAVIANO, TOBIAS & WEINBERGER, P.C. - DETERMINATION - 09/28/98. In the Matter of SAVIANO, TOBIAS & WEINBERGER, P.C. TAT(H) (GC) - DETERMINATION

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1 SAVIANO, TOBIAS & WEINBERGER, P.C. - DETERMINATION - 09/28/98 In the Matter of SAVIANO, TOBIAS & WEINBERGER, P.C. TAT(H) (GC) - DETERMINATION NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION GENERAL CORPORATION TAX - THE NET OPERATING LOSS DEDUCTION OF A SUBCHAPTER S CORPORATION UNDER THE GENERAL CORPORATION TAX CANNOT EXCEED THE AMOUNT OF THE NET OPERATING LOSS DEDUCTION THAT WOULD HAVE BEEN AVAILABLE FOR THAT YEAR FOR FEDERAL INCOME TAX PURPOSES HAD THAT CORPORATION NOT BEEN A SUBCHAPTER S CORPORATION. SEPTEMBER 28, 1998

2 NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION : In the Matter of the Petition : DETERMINATION : of : TAT(H) (GC) : SAVIANO, TOBIAS & WEINBERGER, P.C. : : Schwartz, A.L.J.: Petitioner, Saviano, Tobias & Weinberger, P.C., 3 New York Plaza, 12th Floor, New York, New York, 10004, filed a Petition for a redetermination of deficiencies of New York City ("City") General Corporation Tax ("GCT") under Chapter 6 of Title 11 of the Administrative Code of the City ("Code") for the calendar years 1993 and 1994 (the "Tax Years"). The parties submitted a Stipulation of Facts dated November 7, 1997 with accompanying Exhibits. The Stipulation included a consent to have the controversy determined on submission without a hearing pursuant to 20 RCNY 1-09(f). Petitioner filed a Memorandum of Law on December 30, The Commissioner of Finance (hereinafter "Respondent" or "Commissioner") filed a Reply Memorandum of Law on January 29, Petitioner filed a Memorandum of Law in Further Support of the Petitioner on February 13, Respondent filed a Sur-Reply Memorandum of Law on March 26, Petitioner filed a Memorandum of Law in Response to Petitioner's [sic] Sur-Reply on April 27, Petitioner appeared pro se. Respondent was represented by Karen Griffin, Esq., Assistant Corporation Counsel. Amy F. Nogid,. Esq., and Robert F. Firestone, Esq., Assistant Corporation Counsels also participated on the memoranda.

3 ISSUE Whether Petitioner is entitled to take net operating loss deductions on its City GCT returns for the Tax Years that are in excess of the net operating loss deductions that it is entitled to take on its federal returns for those same years. FINDINGS 0F FACT The facts set forth below are based on the stipulated facts and Exhibits submitted. 1. Petitioner is a professional corporation located at 3 New York Plaza, 12th Floor, New York, New York. It is engaged in the practice of law. 2. For Federal income tax purposes, Petitioner elected to be 1 taxed as an S Corporation. It filed Forms 1120S, U.S. Income Tax Return for an S Corporation, for 1992, the year of its inception, and for the Tax Years (the "Federal Returns"). 3. Petitioner's three officers and only shareholders were David Tobias, Steven Weinberger, and Edward Saviano. 4. Petitioner reported income, deductions, and ordinary losses on its Federal Returns as follows: Total Income $37,955 $729,542 $ 8 5 1, Officers' Comp. (30,067) (593,633) (676,103) All Other Deductions (47,910) (260,091) (298,012) Ordinary Income (Loss) $(40,022) $(124,182) $(122,790) 1 See, Internal Revenue Code ("IRC") 1361 et seq. 2

4 5. Petitioner filed Forms NYC 4S, City GCT Returns, for 1992 and for the Tax Years (the "City Returns"). Since there is no equivalent to an S election for GCT purposes, the starting point for computing Petitioner's GCT liability was its entire net income computed as if there were no Federal S election in effect. 2 Petitioner computed its GCT liability on the City Returns pursuant to the alternative tax measured by entire net income ("ENI") plus compensation of officers (the "Alternative Tax"). 6. Petitioner computed the amount of its ENI plus compensation of officers as follows: Fed. Taxable Income $(124,182) $(124,460) 3 State and City Taxes 11,863 11,323 Total (112,319) (113,137) NYC Net Op. Loss Ded. (40,022) (152,341) Taxable Net Income (152,341) (265,478) Officers' Comp. 593,633) 676,103 Total $441,292 $410, The $40,022 net operating loss deduction claimed by Petitioner on its 1993 City Return was the amount of ordinary loss that it reported on its 1992 Federal Return. 8. The $152,341 net operating loss deduction claimed by Petitioner on its 1994 City Return was computed as follows: 2 Code Petitioner acknowledges that this amount is in error and should have been $(122,790), the amount reported on its Federal Return. -3-

5 Ordinary loss from 1993 Federal Return $(124,182) 1992 net operating loss not used for Federal Tax purposes (40,022) (164,204) Adjustments to Federal Income: 1993 State and City Taxes 11, net operating loss deduction $(152,341) 9. A Notice of Determination, dated April 17, 1996, was issued to Petitioner asserting a GCT deficiency for calendar year 1993 in the amount of $1,544.45, consisting of principal in the amount of $1, plus interest in the amount of $ and a penalty of $ The deficiency resulted from the Department's disallowing Petitioner's claimed net operating loss deduction in the amount of $40,022. A second Notice of Determination, dated April 17, 1996, was issued to Petitioner asserting a deficiency for calendar year 1994 in the amount of $4,486.31, consisting of principal in the amount of $4,044.66, plus interest in the amount of $ This deficiency resulted from the Department's disallowing Petitioner's claimed net operating loss deduction in the amount of $152, Both Notices of Determination asserted as the grounds for the deficiencies that: "[t]he deduction of a net operating loss carryforward from prior years may not exceed and is limited in the amount of the current year's Federal Taxable Income. Form NYC-3L, Schedule B, Line 1, reflects a loss (Section (f) [sic] New York City Administrative Code)." 11. Petitioner filed a request for a conciliation conference. A conciliation conference was held and a Conciliation Decision, dated October 15, 1996, was issued discontinuing the conciliation proceeding as a result of Petitioner's or its duly authorized representative's express disagreement with the Conciliation Bureau's proposed resolution. -4-

6 12. Petitioner timely filed a Petition dated December 6, 1996 with the City Tax Appeals Tribunal requesting a redetermination of the asserted GCT deficiencies for calendar years 1993 and STATEMENT OF POSITIONS Petitioner asserts that the amount of the net operating loss deduction allowed for GCT purposes by Code (f) for any particular year equals the aggregate of all of the net operating loss carrybacks and carryovers to that year even if those losses are not utilized in that year for Federal tax purposes, and even if the same loss had previously been used for City GCT purposes. The Commissioner asserts that the net operating loss deduction allowed by Code (f) may not exceed the amount of the net operating loss carrybacks and carryovers that may actually be utilized on the taxpayer's Federal return for that year. CONCLUSIONS OF LAW Code (f) provides in part that: A net operating loss deduction shall be allowed which shall be the same as the net operating loss deduction allowed under section one hundred seventy-two of the internal revenue code or which would have been allowed if the taxpayer had not made an election under subchapter s of chapter one of the internal revenue code, except that in every instance where such deduction is allowed under this subchapter:... (3) such deduction shall not exceed the deduction for the taxable year allowed under section one hundred seventytwo of the internal revenue code, or the deduction for the taxable year which would have been allowed if the taxpayer had not made an election under subchapter s of chapter one of the internal revenue code. 4 4 Net operating loss deductions are not claimed on the Federal income tax returns of an S corporation. Rather, a loss flows through to the tax returns of the corporation's shareholders in the -5-

7 IRC 172 permits taxpayers to use losses that exceeded taxable income in certain years to offset taxable income in other years. IRC 172(c) defines a net operating loss ("NOL") for any particular tax year as the "excess of the deductions allowed [by the chapter of the IRC dealing with normal income taxes and surtaxes] over the gross income" with certain modifications described elsewhere in IRC 172. IRC 172(b)(1), as in effect during the Tax Years, provided that NOLs may be carried back and forward as necessary to other taxable years, and provides that the losses may be carried back and carried forward until either they are exhausted or the time period within which the losses may be used (generally three years back and then fifteen years forward, during the Tax Years) has expired. IRC 172(a) establishes that such NOL carrybacks and carryovers are deductible by providing that: There shall be allowed as a deduction for the taxable year an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year. For purposes of this subtitle, the term "net operating loss deduction" means the deduction allowed by this subsection. IRC 172(b)(2) describes how much of the NOL carrybacks and carryovers may be used to offset income from particular years and provides that: AMOUNT OF CARRYBACKS AND CARRYOVERS.-- The entire amount of the net operating loss for any taxable year (hereinafter in this section referred to as the "loss year") shall be carried to the earliest of the taxable years to which (by reason of paragraph (1)) such loss may year it is incurred and is included in any net operating loss deduction to which those shareholders may be entitled on their personal income tax returns. IRC For the balance of the discussion in this determination, the federal net operating loss deductions discussed are computed as if Petitioner were not an S corporation. -6-

8 be carried. The portion of such loss which shall be carried to each of the other taxable years shall be the excess, if any, of the amount of such loss over the sum of the taxable income for each of the prior taxable years to which such loss may be carried. For purposes of the preceding sentence, the taxable income for any such prior taxable year shall be computed -- (A) with [certain modifications], and (B) by determining the amount of the net operating loss deduction without regard to the net operating loss for the loss year or for any taxable year thereafter, and the taxable income so computed shall not be considered to be less than zero. The essence of Petitioner's argument is that for purposes of Code (f), the NOL "deduction allowed" under IRC 172 for any particular tax year refers to the NOL deduction as defined by IRC 172(a). That is, the aggregate of all NOL carrybacks and NOL carryovers that could be available for any tax year is the amount that may be deducted against GCT taxable income for that year. In making its argument, Petitioner completely ignores IRC 172(b) which determines how much of the carryovers and carrybacks may be deducted in any particular year for Federal purposes. Petitioner also ignores whether or not such NOL carryovers and NOL carrybacks are needed in order to offset Federal taxable income in that tax year, and whether or not such NOL carrybacks and carryovers had previously been used for City purposes. Respondent, however, asserts that the NOL "deduction allowed" under IRC 172 for any tax year is the amount of the NOL carrybacks and NOL carryovers that could actually be utilized for Federal tax purposes in that tax year. As the facts indicate, Petitioner's interpretation of the statute yields an absurd result. -7-

9 In 1992, as well as in both of the Tax Years, Petitioner reported a loss for Federal tax purposes. Petitioner's losses resulted from its having paid substantial salaries to its officers/shareholders that were well in excess of the revenues of the business less its other expenses. Because it was an S corporation for Federal income tax purposes, Petitioner's losses flowed through to its officers/shareholders' personal income tax returns and would have been available to offset a portion of the 5 salaries paid to those officer/shareholders. For City GCT purposes, however, Petitioner was taxed under the Alternative Tax, 6 a mechanism which, due to the add-back of officers' compensation, is geared to collecting some tax under this type of arrangement. For City GCT purposes, Code (f) requires that Petitioner's NOL deductions be computed as if it were not an S corporation. For Federal tax purposes, since it had losses each year due to the large salaries paid to officer/shareholders, Petitioner did not need to use nor could it use the losses from any other year as NOL deductions. Accordingly, the NOLs incurred each year remained available as NOL carrybacks or carryovers that could be used in a future year if there were a future year in which there were Federal taxable income. These aggregate losses remained available as NOL deductions for Federal purposes as defined by IRC 172(a). Not only does Petitioner seek to use these losses for City GCT purposes in years in which they were not needed for Federal tax purposes, Petitioner also claims that the same losses may be used over and over again. Petitioner's novel interpretation of the law is more than mere "double-dipping" for it would result in what can best be termed the "Eveready Bunny tax deduction," a deduction that just keeps going, and going, and going. 5 6 IRC See, Code (E)(3). -8-

10 In 1992, Petitioner's first year of operations, Petitioner had an NOL for Federal income tax purposes of $40,022. This NOL was available as an NOL carryover for However, in 1993, Petitioner also had a loss for Federal income tax purposes. Since it had a loss in 1993, it did not utilize any of the available NOL carryover of $40,022 from In 1994, Petitioner again had a loss for Federal income tax purposes. Once again, because it had a loss in that Tax Year, it did not need to utilize any of the NOL carryover of $40,022 from 1992 nor did it utilize the NOL carryover of $124,182 from Because it was subject to the Alternative Tax for GCT purposes, Petitioner had City taxable income against which it seeks to claim a NOL deduction. Petitioner asserts that since, for Federal tax purposes, the 1992 NOL of $40,022 is a NOL carryover for 1993, it is a NOL deduction allowed under IRC 172, as Code (f) requires, and may be utilized on its 1993 City Return. Petitioner further claims that since this loss was not used for Federal tax purposes in 1993, and thus was still available for Federal tax purposes as an NOL carryover to 1994, it may again use the same $40,022 loss that it claims it may use to reduce its 1993 GCT taxable income to reduce its 1994 GCT taxable income. Petitioner claims that it may also use the NOL of $122,790 that was generated in 1993, to reduce its 1994 GCT taxable income, resulting in a total City NOL deduction (before City adjustments) for 1994 of 7 $162,812 ($40,022 + $122,790). Under Petitioner's analysis, so long as this loss has not been used for Federal tax purposes, it may be used again and again during the fifteen year period in which an NOL could be carried forward under IRC 172 as in effect during the Tax Years. Fortunately, for the sound administration of the tax law, Petitioner does not prevail in its theory. At the outset it should be noted that while Petitioner asserts 7 Corrected for the error noted in footnote 2, supra. -9-

11 that Code (f) is unambiguous and in its favor, it also argues, in the alternative, that should the provision be deemed unclear, it must be interpreted to favor the taxpayer because tax statutes must be strictly construed against the government. However, Petitioner neglects to note that the rule of statutory construction upon which it relies applies to statutes that impose a tax and not to statutes providing a deduction or exemption from tax. It is black letter law that deductions are a matter of legislative grace and should be narrowly construed. The burden of establishing the entitlement to a deduction falls squarely on the Taxpayer. Matter of Grace v. NYS Tax Commn., 37 N.Y.2d 193, 197, 371 N.Y.S.2d 715 (1975). In this instance, Petitioner has not met that burden. With respect to the issue before me, the New York State Tax Appeals Tribunal ("State Tribunal") has issued a decision that is 8 directly on point and is dispositive of this case. In Matter of Refco Properties, Inc., DTA No , CCH NY State Tax Rptr (NYS Tax Appeals Tribunal, July 11, 1996), the State Tribunal addressed the question of whether a taxpayer may claim an NOL deduction on its New York State ("State") Corporate Franchise Tax return which exceeds the amount of the NOL deduction properly reported on its Federal corporation income tax return for a taxable year. In Refco, the taxpayer's taxable income for State Franchise Tax purposes exceeded its Federal taxable income because of certain additions to New York taxable income such as the depreciation adjustment required by Tax Law 208(9). As a result, the taxpayer 8 City Charter 170(d) mandates that the City Tribunal "shall follow as precedent the prior precedential decisions of... the New York State Tax Appeals Tribunal... insofar as those decisions pertain to any substantive legal issues currently before the tribunal." In order for a State Tribunal's decision to be binding on the City Tribunal, the issues before this Tribunal must have actually been determined by the State Tribunal. Matter of U.S. Trust Corp. and Subsidiaries, TAT(E) 93, 204 (BT), TAT(E) (BT), and TAT(E) (BT) (NYC Tax Appeals Tribunal, November 25, 1997). -10-

12 would have been able to utilize a larger NOL deduction for State Franchise Tax purposes than it could have utilized for Federal corporate income tax purposes and it claimed such larger NOL deduction on its State Franchise Tax returns. The relevant portion of the statutory provision which was at issue in Refco, Tax Law 208(9)(f), is virtually identical to its counterpart in Code section (f), and provides in pertinent part that: A net operating loss deduction shall be allowed which shall be presumably the same as the net operating loss deduction allowed under section one hundred seventy-two of the internal revenue code (3) such deduction shall not exceed the deduction for the taxable year allowed under section one hundred seventytwo of the internal revenue code.... The State Tribunal decided in Refco that for purposes of the State Franchise Tax, the State NOL may not exceed the amount of the Federal NOL necessary to reduce Federal taxable income to zero. The State Tribunal explained its decision as follows: If section 208(9)(f) of the Tax Law provided that the New York State NOL was presumably the same as the NOL deduction allowed under IRC 172(a), petitioner would have a stronger base for its argument. However, Tax Law 208(9)(f) provides that a NOL deduction shall be allowed which is presumably the same as that allowed under IRC 172, not just 172(a). Therefore, the limitation of the amount of the NOL carryovers and carrybacks contained in section 172(b)(2) must also be considered. In reaching its decision, the State Tribunal found the Court of Appeals' decision in Royal Indemnity Company v. Tax Appeals Tribunal, 75 N.Y.2d 75, 550 N.Y.S.2d 610 (1989) to be dispositive. -11-

13 In Royal Indemnity, which dealt with a similar NOL provision under the State Franchise Tax on Insurance Companies ("Insurance Franchise Tax"), the taxpayer carried certain losses back for Federal tax purposes. It could not carry those losses back for State tax purposes because it was not subject to the Insurance Franchise Tax during the carryback years. It sought to carry forward those losses that had not been used for State tax purposes. Since those losses had previously been carried back and used up for Federal tax purposes, the carryover loss claimed for State purposes would have exceeded the loss claimed for Federal purposes for that year. In Royal Indemnity, the Court of Appeals held that "the New York net operating loss deduction cannot exceed the amount deducted on the Federal return for the corresponding year" and disallowed the claimed deduction. 550 N.Y.S.2d at 612. In its brief, Petitioner relies extensively on Matter of Avien, Inc., 532 F.2d 273 (2nd Cir. 1975), a case in which the Second Circuit Court of Appeals reviewed a bankruptcy judge's decision construing the precursor to Code (f). In that 1975 case, the Second Circuit interpreted City law in a manner that permitted the taxpayer to take an NOL deduction for City purposes that exceeded the Federal NOL deduction (although each loss was deducted only once for City purposes). However, Petitioner neglected to note that in 1989, the New York Court of Appeals in Royal Indemnity, supra, explicitly stated that it declined to follow Avien. Royal Indemnity, 550 N.Y.S.2d at 611. Accordingly, Avien is not the law in New York. Based on Refco, supra, and Royal Indemnity, supra, I find that for GCT purposes, the NOL deduction that may be deducted by a taxpayer for any Tax Year may not exceed the amount of the NOL deduction that could have been utilized for Federal corporation income tax purposes for the same Tax Year. Because Petitioner is an S corporation, in accordance with Code (f)(3), the -12-

14 allowable NOL deduction is that amount which Petitioner would have been allowed had it not been an S corporation. ACCORDINGLY, IT IS CONCLUDED THAT the City net operating loss deduction cannot exceed the amount that could have been utilized on Petitioner's Federal corporation income tax return for the same Tax Year had it not been an S corporation. The Petition of Saviano, Tobias & Weinberger, P.C. dated December 6, 1996 is therefore denied and the Notices of Determination dated April 17, 1996 are sustained in full. Dated: September 28, 1998 New York, New York MARLENE F. SCHWARTZ Administrative Law Judge -13-