A North Carolina court ruled that a corporation had to reduce its net economic loss (NEL) deduction by the dividend income it deducted for federal income tax purposes.
NEL Reduction for Nontaxable Income
The corporation received over $4 million in dividends from its subsidiaries for the tax years in question. It deducted the dividends from taxable income it reported on its federal return.
The corporation’s North Carolina return included its federal taxable income after its dividends received deduction (DRD). It applied NEL carryforwards to its remaining North Carolina taxable income and reported zero net income.
During the tax years in question, North Carolina law required the corporation to reduce its NELs by nontaxable income. The court concluded that dividend income was nontaxable income under the law because North Carolina does not tax that income. Its conclusion relied on:
– statutory construction;
– the North Carolina Supreme Court’s decision in Dayco Corp. v. Clayton; and
– long-standing administrative guidance.
It agreed with North Carolina that the corporation underreported tax liability because it failed to:
– treat the dividend income as nontaxable income; and
– reduce its NELs by the nontaxable dividend income apportioned to North Carolina.
The court also concluded that the state’s interpretation of the law did not violate the U.S. or North Carolina Constitution. The state based its interpretation on:
– the Dayco holding, which the legislature had not decided to overturn or modify; and
– a position it announced and followed for at least 20 years, including the tax years at issue.
There was no evidence that North Carolina:
– applied the interpretation inconsistently, arbitrarily, or discriminatorily; or
– identified the corporation for adverse treatment relative to other taxpayers in similar situations.
North Carolina Department of Revenue v. Graybar Electric Co., North Carolina Superior Court, No. 17 CVS 13902, January 9, 2019, ¶202-821