At a recent state and local tax conference, the New York State Department of Taxation and Finance (DTF) and the New York City Department of Finance (DOF) addressed the high percentage of corporate tax returns that contain common errors regarding the prior net operating loss conversion (PNOLC). This article will summarize some important factors that business owners and advisors should be aware of in connection with reporting the PNOLC, as noted at the conference.
Prior Net Operating Loss Conversion Computation
The June 2016 installment of this column (“New York State and City Prior Net Operating Loss Conversion,” http://bit.ly/2BeO4VK) detailed the manner in which the PNOLC computation is accomplished and the deduction limitations applicable to the use of the PNOLC. In accordance with the draft PNOLC regulations posted by the DTF and DOF on May 5, 2017, a taxpayer with unutilized and eligible net operating loss carryovers from tax years prior to 2015 must first compute its net operating loss carryovers based on the rules in effect on Dec. 31, 2014; the amounts so determined constitute the unabsorbed net operating loss (UNOL).
Once the UNOL has been determined, it must be converted to PNOLC in order to be utilized on a going-forward basis. This is done by multiplying the UNOL by the base-year business allocation percentage, multiplying that result by the appropriate base-year tax rate, and dividing by either 6.5% for New York State or 8.85% for New York City. The result of this computation is the PNOLC pool, which can be utilized or carried forward for 20 periods.
For combined filers, each member of the combined group must compute its own PNOLC by multiplying the combined group’s UNOL by the percentage of such member’s losses included therein. Special rules apply where there were changes in the combined group during the 2015 tax year.
Limitations on the Use of the PNOLC
In addition to converting the pre-2015 net operating loss carryovers to the PNOLC, the draft regulations also provide several deduction limitations:
- The taxpayer is allowed to utilize 1/10 of its PNOLC pool in one tax period; after the 10th tax period, the 1/10 limitation no longer applies, and the remaining unused PNOLC pool can be fully applied against taxable income.
- New York State small business corporations, as defined under New York State Tax Law section 210.1(f) as in effect on December 31, 2014, are not subject to the 1/10 PNOLC deduction limitation if the corporation makes a small business election in its originally filed 2015 return. New York City does not have a special provision for small business corporations.
- A taxpayer can also make a revocable 50% election in its originally filed 2015 return, which allows the taxpayer to utilize 50% of its PNOLC pool against taxable income in the 2015 tax period and the remaining balance of its PNOLC pool in the 2016 tax period; however, no PNOLC can be utilized thereafter. It should be noted that, to revoke the 50% election, the taxpayer must file an amended 2015 return within the applicable statute of limitations period, which is three years following the filing of the original 2015 return, taking valid extensions into account.
- A corporation that did not have UNOL or a business allocation percentage in its base year, or was not subject to tax in its base year, is not allowed a PNOLC subtraction. In addition, regulated investment companies and corporations that were New York S corporations in the base year are also not allowed a PNOLC subtraction.
Common Reporting Errors
Taking the above into account, the items listed below were noted at the conference as being some of the common errors with respect to the PNOLC reporting:
- Reporting the PNOLC on line 18 instead of line 16 of Part 3 of the New York State corporate return (Form CT-3), and on line 35 instead of line 33 of schedule B of the New York City corporate return (Form CT-2)
- Adding 2015 net operating loss with the PNOLC and reporting the total on line 16 of Part 3 of Form CT-3, and on line 35 of schedule B of Form CT-2
- Deducting the PNOLC or NOL when the corporation did not have any New York State–or City–apportioned business income in the 2015 tax year
- Reporting negative values in the respective PNOLC and NOL lines in the New York State or New York City corporate returns
- The business allocation percentage applied to the PNOLC not matching what was reported in the 2014 return.
The authors recommend that taxpayers and their return preparers review their filed 2015 New York State and New York City corporate tax returns to determine if their PNOLCs were reported correctly.
As mentioned above, taxpayers should review their filed 2015 tax return to determine if their PNOLCs were reported correctly. Based on the DTF and DOF’s proposed draft regulations, the PNOLC reported in the 2015 tax return is a fixed number that can only be changed by amending the return prior to the expiration of the applicable three-year statute of limitations. In addition, federal, New York State, and New York City audit changes, with regard to net operating losses incurred prior to January 1, 2015, will have an impact on the PNOLC unless the statute of limitations for the 2015 tax return has expired. Furthermore, the 50% PNOLC deduction election is revocable, but a taxpayer who wishes to revoke it must file an amended return prior to the running of the statute of limitations applicable to its 2015 tax return.
Needless to say, this is a complex area that is constantly evolving. The DTF and DOF are reviewing returns reflecting the PNOLC in detail, and therefore it is very important that CPAs review and, where needed, amend and correct any of the above errors before the statute of limitations for 2015 expires.