With many state legislatures in full swing, state responses to changes in the NOL deduction made by the Tax Cuts and Jobs Act of 2017 (P.L. 115-97) (TCJA) are becoming more clear. States differ in how they treat the changes on state corporate income tax returns, but the responses are closely tied to state conformity. Being aware of these changes and the trends in state responses can provide tax planning opportunities for corporate income taxpayers.
Net Operating Losses under the Tax Cuts and Jobs Act of 2017
The TCJA made several important changes to the rules governing net operating loss carryover deductions that impact state taxes. These changes include:
- limiting the NOL deduction to 80% of taxable income in the carryforward year;
- eliminating the NOL carryback period; and
- allowing an indefinite NOL carryforward period.
NOLs sustained prior to the effective date of these changes are governed by prior law.
Before the Tax Cuts and Jobs Act (TCJA) was enacted, a NOL could be carried back two tax years and carried forward up to 20 years. A limitation based on taxable income was also not imposed by the Code.
How Are States Responding to the 80% Limitation?
Under TCJA, while the new carryforward period is indefinite, the NOL deduction is limited to 80% of taxable income in the carryforward year. This change prohibits corporations from using NOLs to completely eliminate tax liability.
Most state responses are determined by whether the state NOL deduction is based on the IRC, or more specifically, IRC Sec. 172. States like Alaska and Florida expressly reference IRC Sec. 172 in their controlling statute. As such, they follow the new 80% limit.
However, the majority of states are not impacted by this change at this point.
How Are States Responding to Elimination of the Federal NOL Carryback Period?
The elimination of the two-year federal carryback period has not impacted many states’ carryback periods. This is largely because many states did not permit carrybacks prior to the enactment of TCJA.
A small minority of states that expressly conform to the federal carryback period are seeing a decrease in their state’s carryback periods. For example, Delaware and Georgia specifically follow federal law in regards to federal NOL carryback periods.
Additionally, some states have recently enacted legislation to eliminate the NOL carryback period. For example, Utah passed a law prohibiting NOL carrybacks in July 2018. Prior to enactment, a Utah net loss could be carried back three taxable years.
How Are States Responding to Indefinite Federal NOL Carryforward Period?
The largest group of states seeing a change resulting from the TCJA changes are those that conform the state carryforward period to IRC Section 172(b). These states provided a 20 year carryforward period, but now allow NOLs to be carried forward indefinitely. Examples of states impacted in this way include:
By Catherine S. Agdeppa, J.D.