Could a corporation use federal net operating losses from before 1991 to reduce later former Texas earned surplus?

Plain-English summary

Federal NOL deductions did not reduce earned surplus; only the separate Texas business-loss carryforward applied.

Section 171.110(d) began the former earned-surplus computation with federal taxable income after Schedule C special deductions but before federal net operating loss deductions. Texas therefore did not allow a federal NOL deduction against earned surplus.

Texas had its own business-loss deduction for a negative amount after apportionment. That loss could carry forward for five years or until exhausted, could not reduce earned surplus below zero, and could not include a loss from a tax year ending before January 1, 1991.

The taxpayer's pre-1991 federal losses could not offset earned surplus in later years, so the Comptroller denied the refund claims. The letter offered a refund hearing if requested in writing within 20 days, a taxpayer-specific historical deadline.

What this means for you

Corporations reviewing historical loss carryforwards

A federal NOL and a Texas business loss were different items with different calculation and timing rules.

Tax professionals

Start before the federal NOL deduction, compute any Texas business loss after apportionment, and apply the historical cutoff and carryforward limits.

Common questions

Q: Could the taxpayer deduct its federal NOL?
A: No.

Q: What loss could carry forward?
A: A negative amount after Texas apportionment, subject to the statutory limits.

Q: Could a pre-1991 loss reduce later earned surplus?
A: No.

Citations and references

• Texas Tax Code Sec. 171.110(a)(4), (d), and (e)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9702417L

Original ruling text

February 26, 1997

RE: CORPORATION A
Texas Taxpayer Number: ***

Dear ***:

I have reviewed the amended franchise tax reports for the 1993 through 1995
report years that you recently submitted. We discussed these amended reports
in a phone conversation on February 18, 1997. As we discussed in that
conversation, your refund claims have been denied. This letter is a follow-up
to that conversation.

Under the Texas Tax Code (TTC) 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.

However, TTC Section 171.110(a)(4) provides for the deduction of a business
loss, which is defined in TTC Section 171.110(e) as "any negative amount after
apportionment." TTC Section 171.110(e) provides that a business loss must be
carried forward five years or until the loss is exhausted, whichever occurs
first. This section of the TTC also states that "a business loss from a tax
year that ends before January 1, 1991, may not be used to reduce net taxable
earned surplus." A business loss that is carried forward to a successive year
may not reduce the amount of earned surplus below zero.

Therefore, the federal net operating loss incurred by your client in the
federal tax year(s) prior to January 1, 1991, may not be used to offset earned
surplus in subsequent years.

This response is based on the facts presented in your refund request, our
February 18 phone conversation, and current law.

You are entitled to a refund hearing. If you would like to request one, please
send your written request within twenty (20) days of the date of this letter to
the Audit Processing Section of Revenue Accounting. This request must be
accompanied by a copy of this letter and any documentation needed to support
your claim.

If you have any questions about this or any other franchise tax matters, please
write me or call me at 1-800-531-5441, extension 34612. My regular number is
(512)463-4612.

Sincerely,

Janet Spies
Tax Policy Division

cc: Troy Hill, Revenue Accounting