Can Virginia disallow a corporation's net operating loss carryforward for lack of documentation, and how are NOLs inherited in a bankruptcy reorganization treated?

Plain-English summary

A corporation and its subsidiaries filed consolidated federal and Virginia returns for 2017. The group had a net operating loss (NOL) from earlier years that it carried forward and used to reduce its 2017 income. On audit, the Department found the group's documentation for the NOL carryforward insufficient, disallowed the deduction, and layered on other adjustments — reworking the group's federal taxable income for 2011–2017 to account for cancellation-of-debt (COD) income and capital-loss add-backs, reclassifying a subsidiary the group had treated as a financial corporation for apportionment, and disallowing an amount claimed as nonbusiness income. The group appealed.

The Commissioner sided with the taxpayer and reversed the NOL adjustment, which by itself wiped out the assessment:

• Virginia follows the federal NOL. Virginia's tax laws don't separately govern the NOL deduction; because Virginia taxable income starts from federal taxable income (§ 58.1-301), Virginia allows the NOL deduction to the extent it's allowable federally.
• An IRS private letter ruling controlled the inherited NOL. The NOL came from years before the group's 2009 bankruptcy reorganization. An IRS PLR said the group inherited the dissolving company's NOL as of the reorganization date. The auditor had assumed the group only inherited the predecessor's NOL as of a later dissolution — but the PLR was clear, and on appeal the Department confirmed the larger, earlier NOL was the one properly carried forward.
• The COD add-back was wrong. The Department had increased the group's income for cancellation-of-indebtedness income, but the group had already reduced its NOL to account for that income under IRC § 108 — so adding it back double-counted. The basis for the capital-loss add-backs was also unclear.
• Other schedule errors were confirmed too (a 2015 NOL that wasn't carried forward on the audit schedule, and a 2016 federal revenue-agent-report adjustment that never happened).

Because fixing the NOL deduction produced a full abatement of the assessment, the remaining issues (financial-corporation apportionment and nonbusiness income) were moot and not decided.

What this means for you

Corporations carrying forward NOLs

Keep — and be ready to produce — the documentation trail for any NOL carryforward, especially one that survives a merger, reorganization, or bankruptcy. But note the flip side of this ruling: the Department will correct its own audit errors on appeal. If an auditor mis-dates an inherited NOL or double-counts income you already absorbed, a well-supported appeal can reverse it entirely.

Companies coming out of bankruptcy reorganization

Where an IRS private letter ruling fixes how much NOL you inherit and as of what date, that governs the Virginia carryforward too (Virginia starts from federal taxable income). And watch IRC § 108: if you've already reduced your NOL for cancellation-of-debt income, that income shouldn't be added back again.

Tax professionals

This is a useful example of an appeal succeeding on a single dispositive issue (the NOL) that mooted every other adjustment. When one issue can abate the whole assessment, lead with it — and document the federal starting point (FTI, the IRS PLR, the § 108 attribute reduction) precisely.

Common questions

Q: Does Virginia have its own net operating loss rules?
A: Not really. Virginia taxable income starts from federal taxable income (§ 58.1-301), so Virginia allows the NOL deduction to the extent it is allowable in computing federal taxable income.

Q: The auditor said my NOL documentation was insufficient. Is that the end of it?
A: No. As this ruling shows, you can appeal, and the Department will reverse adjustments that turn out to be wrong — here, a mis-dated inherited NOL and a double-counted item of income.

Q: How is an NOL inherited in a bankruptcy reorganization measured?
A: Per the governing IRS private letter ruling. Here the group inherited the predecessor's NOL as of the reorganization date, not a later dissolution date.

Q: What is the IRC § 108 point?
A: Cancellation-of-debt income can be excluded from income but requires reducing tax attributes such as NOLs. Because the group had already reduced its NOL for that income, the Department's add-back of the same income was erroneous.

Citations and references

Statutes:

• Va. Code § 58.1-301 — Virginia conforms to Internal Revenue Code terminology; Virginia taxable income is computed starting from federal taxable income, so the NOL deduction is allowed to the extent allowable federally
• IRC § 108 — cancellation-of-indebtedness income and the corresponding reduction of tax attributes such as net operating losses

Other authority (described here rather than linked): an IRS private letter ruling establishing that the taxpayer inherited the predecessor company's NOL as of the 2009 reorganization date.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-12

Original ruling text

March 4, 2026

Re: § 58.1-1821 Application: Corporate Income Tax

Dear * :

This will respond to your letter in which you seek correction of the corporate income tax assessment issued to * (the “Taxpayer”) for the taxable year ended December 31, 2017.

FACTS

The Taxpayer and its subsidiaries filed consolidated federal and Virginia corporate income tax returns for the 2017 taxable year. The Taxpayer reported a net operating loss (NOL) from prior taxable years that it carried forward and utilized to claim a net operating loss deduction (NOLD) against its federal taxable income (FTI). Under audit, the Department concluded that the Taxpayer had provided insufficient documentation to support its NOL carryforward. The auditor also adjusted the Taxpayer’s federal taxable income for the 2011 through 2017 taxable years to account for capital loss additions and cancellation of debt income that impacted the NOL available for the 2017 taxable year.

In addition, the Taxpayer had characterized one subsidiary (the “Subsidiary”) as a financial corporation for apportionment purposes. The Department determined that the Subsidiary was not a financial corporation and, even if it was a financial corporation, it had not elected to be taxed as a financial corporation. The audit staff adjusted the Subsidiary’s apportionment factors accordingly. Finally, the Department disallowed an amount that the Taxpayer had characterized as nonbusiness income not subject to apportionment.

The Taxpayer submitted an application for correction contending that the adjustments to its NOLD did not properly account for NOLs derived from taxable years that occurred before a bankruptcy reorganization and did not correctly account for certain adjustments to its NOL attributable to cancellation of debt income and capital loss addback. The Taxpayer also contends that the Subsidiary properly apportioned its income as a financial corporation because no election was required. Finally, the Taxpayer argues that it correctly reported its nonbusiness income based on established case law.

DETERMINATION

In general, Virginia income tax laws do not address the NOLD. Nonetheless, Virginia Code § 58.1 301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code (IRC), unless a different meaning is clearly required. Because the starting point in computing Virginia taxable income is FTI, Virginia allows a NOLD to the extent that it is allowable in computing FTI.

The NOL at issue was derived from taxable years that preceded the Taxpayer’s bankruptcy reorganization in 2009. The Taxpayer received a private letter ruling from the Internal Revenue Service (IRS) providing, in relevant part, that the Taxpayer would inherit the NOL of the dissolving company as of the reorganization date. It appears that the auditor believed the Taxpayer was only permitted to inherit the NOL of the predecessor company as of the time of its dissolution several years after the 2009 reorganization. However, the PLR is clear that the TP would inherit the NOL as it existed at the time of the reorganization itself. On appeal, the Department has confirmed it was in fact that NOL the Taxpayer began carrying forward.

In addition, the Department erroneously increased the Taxpayer’s FTI for certain taxable years following the reorganization in an attempt to account for cancellation of indebtedness income and capital loss addbacks. With respect to the cancellation of indebtedness income, the Taxpayer had already reduced its NOL carryforward to account for this income, which was again attributable to the later dissolution of the predecessor organization. See IRC § 108. Further, it is unclear on what basis the audit staff added back capital loss deductions.

Finally, the Taxpayer points out several other errors impacting the FTI showing on the Department’s schedule of audit adjustments, namely a NOL for the 2015 taxable year that was not carried forward on the schedule and a federal revenue agent report (RAR) adjustment for the 2016 taxable year that did not occur.

Based on the foregoing, the adjustment to the Taxpayer’s NOLD will be reversed. Because the determination with respect to the NOLD will result in the full abatement of the assessment, the remaining issues are moot.

The Code of Virginia sections cited are available online at law.lis.virginia.gov . If you have any questions regarding this determination, you may contact * in the Office of Tax Policy and Legal Affairs, Tax Adjudication and Resolution Division, at or **.

Sincerely,

Kristin L. Collins
Tax Commissioner
Commonwealth of Virginia

AR/4259.X