Must a Texas franchise taxpayer file the long form to preserve a business loss carryforward, and how does the carryforward work?

Plain-English summary

A taxpayer asked whether filing the franchise-tax long form was necessary to preserve or add to a loss carryover on the (pre-2008) Texas franchise tax. The Comptroller said the long form is not required, and explained how the state's business loss carryforward works.

• No federal NOL deduction. The earned-surplus computation starts from a corporation's federal taxable income after Schedule C special deductions and before net operating loss deductions (Tax Code Sec. 171.110(d)). Texas does not allow a deduction against earned surplus for a federal net operating loss.
• A Texas "business loss" is different. Sec. 171.110(a)(4) allows a deduction for a business loss, defined in Sec. 171.110(e) as any negative amount after apportionment and allocation.
• Carryforward rules. A business loss must be carried forward five years or until exhausted, whichever comes first. It cannot be carried back to a prior report, and a carryforward cannot reduce earned surplus below zero.
• Use it when you have positive earned surplus. In any year with positive earned surplus - even if no tax will be owed - the taxpayer must apply the available business loss carryover to reduce net taxable earned surplus to zero (Rule 3.555(g)(2)).
• Recordkeeping, not a long form. You are not required to file a long form to preserve or add to the carryover, but you should keep a worksheet to substantiate the loss in case of audit.

Currency note: This is the pre-2008 franchise tax and its earned-surplus/business-loss regime, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. Treat as historical.

What this means for you

Business owners tracking losses

You did not need to file the long form just to bank a business loss, but you did need to document it. And you could not simply save the loss for a better year - once you had positive earned surplus, you had to apply the carryover, and any unused loss expired after five years.

Accountants and tax professionals

Distinguish the federal NOL (not deductible against earned surplus) from the Texas business loss (deductible under Sec. 171.110(a)(4)). Apply Rule 3.555(g)(2)'s mandatory-use rule and the five-year limit, and keep carryforward worksheets even for No Tax Due years.

Common questions

Q: Do I have to file the long form to keep my loss carryforward?
A: No. You can preserve or add to a business loss carryforward without the long form, but keep a worksheet to substantiate it.

Q: How long does a business loss last, and can I carry it back?
A: It carries forward five years or until exhausted, whichever is first, and cannot be carried back.

Q: Can I choose not to use the loss in a profitable year?
A: No. In any year with positive earned surplus you must apply the carryover to reduce net taxable earned surplus to zero.

Citations and references

Statutes and rules:

• Tex. Tax Code Sec. 171.110(d) (earned surplus starts before the NOL deduction)
• Tex. Tax Code Sec. 171.110(a)(4) (business loss deduction)
• Tex. Tax Code Sec. 171.110(e) (business loss defined; 5-year carryforward; no carryback)
• 34 Tex. Admin. Code Sec. 3.555(g)(2) (mandatory application of the carryforward)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200410893L

Original ruling text

October 28, 2004

To: **

Dear **:

Thank you for your Tax Help inquiry concerning the filing of Texas franchise
tax. You ask if it is necessary to file the franchise tax long form in order
to preserve or add to a net operating loss carryover.

The statutes and rule I mention below, as well as other related information,
are available online at
http://www.window.state.tx.us/taxinfo/franchise/index.html.

Under Texas Tax Code Section 171.110(d), the beginning point for computing
earned surplus is the corporation's "federal taxable income after Schedule C
special deductions and before net operating loss deductions as computed under
the Internal Revenue Code." Texas franchise tax law does not permit a
deduction against earned surplus for a federal net operating loss.

Tax Code Sec. 171.110(a)(4) does, however, allow for a deduction of a business
loss, which is defined in Tax Code Sec. 171.110(e) as "any negative amount
after apportionment and allocation." Tax Code Sec. 171.110(e) provides that a
business loss must be carried forward five years or until the loss is exhausted
whichever occurs first. A business loss that is carried forward to a
successive year may not reduce the amount of earned surplus below zero. A
business loss cannot be carried back to reduce taxable earned surplus on a
previous report.

Additionally, any year in which the taxpayer has any amount of positive earned
surplus (even if the taxpayer will owe no tax on earned surplus), the taxpayer
must use any available business loss carryover to reduce net taxable earned
surplus to zero. Franchise tax rule 3.555(g)(2) states "a business loss which
is carried forward to a successive year must be applied to the extent of
apportioned plus allocated taxable earned surplus in that succeeding year."

You are not required to file a long form franchise tax report to preserve or
add to your business loss carryover for use in future years. You should keep a
worksheet to substantiate your loss carryforwards in case you are ever audited.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

Our goal is to provide you with prompt, professional service. Please take a
moment to complete our on-line survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 59952.

Sincerely,

Teresa Bostick
Tax Policy Division