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Are New York’s PNOLC Draft Regulations Too Restrictive?

R. Gregory Roberts, Esq., Jennifer S. White, Esq., and Jeremy P. Gove, Esq.
Published Date:
Jan 1, 2018

On May 5, 2017, the New York State Department of Taxation and Finance (the “Department”) released its long-awaited draft regulations (the “Draft Regulations”) regarding the computation of the prior net operating loss conversion (“PNOLC”) subtraction. Initial comments to the Draft Regulations were due Aug. 3, 2017; however, the Department continues to review comments. This article analyzes and provides insights with regard to two issues created by both the statute and the Draft Regulations: (i) the interplay between the reduced New York State corporate income tax (“Tax”) rates available to qualified New York manufacturers and the PNOLC subtraction and (ii) the statute of limitations set forth in the Draft Regulations regarding the PNOLC subtraction pool.

How is the PNOLC Subtraction Calculated?

Prior to the passage of New York’s 2015 Tax reform, net operating losses (“NOLs”) were accumulated and applied on a pre-apportionment basis. Since, however, the new Tax regime went into effect for tax years beginning on or after Jan. 1, 2015, NOLs are now applied on a post-apportionment basis. The new Tax law allows taxpayers to monetize their pre-tax reform NOLs into a “post-apportioned” deduction—the PNOLC subtraction—which may be used over a number of years to reduce a taxpayer’s New York apportioned income. 

To calculate the amount of its PNOLC subtraction pool, a taxpayer must first determine the amount of its unabsorbed NOLs, which—under New York Tax Law sections 210.1(a)(viii)(B)(1)(I) and (II)—are NOLs “that were not deductible in previous taxable years and [were] eligible for carryover” on the last day of its Tax year under the previous Tax laws (the “base year”). The base year is generally the 2014 Tax year. The unabsorbed NOL then is multiplied by the base year allocation percentage and the income base Tax rate. The resulting number is then divided by 6.5%. This yields the PNOLC subtraction pool.

Most taxpayers have two ways of using their PNOLC subtraction pool. Under the first option (New York Tax Law section 210.1(a)(viii)(B)(2)(III)), a taxpayer may use one-tenth of its PNOLC subtraction each Tax year and carry over any excess to subsequent tax years. Small business taxpayers may also use up to 100% of their PNOLC subtraction to reduce their tax to the next highest tax base. Under this alternative, taxpayers may claim the PNOLC subtraction for 20 years or until their subtraction pool is depleted, whichever comes first. 

Under the second option, a taxpayer can elect to use up to half of its PNOLC subtraction in the first Tax year beginning on or after Jan. 1, 2015, and the remaining half of its PNOLC subtraction in its next Tax year, beginning on or after Jan. 1, 2016. This revocable election must be made on the taxpayer’s original timely filed return for the 2015 tax year. As original returns for the first Tax year beginning on or after Jan. 1, 2015 have already been filed, taxpayers who did not choose the 50/50 option will be relegated to the one-tenth option.

The Draft Regulations

The Draft Regulations provide much-needed guidance on the computation of the PNOLC subtraction pool and the use of the deduction. They contain a large number of examples to outline the application of the law based on various changes to a taxpayer’s combined group, as well as the effects of mergers and dissolutions. The Draft Regulations, however, have failed to address some lingering questions and have in some instances raised new questions by arguably impermissibly expanding or narrowing the Tax law as drafted. 

Qualified New York Manufacturers and the PNOLC Subtraction

For Tax years beginning on or after Jan.1, 2014, a “qualified New York manufacturer” will benefit from reduced Tax rates, including a 0% income base Tax rate. Accordingly, a taxpayer that is a qualified New York manufacturer in their base year (i.e., 2014) will have no PNOLC subtraction pool because their base year Tax rate is zero. The Draft Regulations (section 3-9.5(c)) have confirmed this logic by explicitly stating that a corporation with a base year Tax rate of 0% is “not allowed” a PNOLC subtraction.

For a qualified New York manufacturer that continues to benefit from the zero rate over the following twenty years (the period during which the PNOLC subtraction pool may be utilized), not having a PNOLC subtraction presents no injustice because the taxpayer will have no income Tax base liability requiring the use of a PNOLC subtraction. Consider, however, a taxpayer that loses its status as a qualified New York manufacturer at some point in the future. This taxpayer would arguably lose all ability to monetize and utilize its pre-Tax reform unapportioned NOLs, even though it is now subject to Tax on the income base. 

Is this the result intended by the Department? Consider the following two scenarios in which this situation seems plausible.

1. The Taxpayer No Longer Qualifies for the Reduced Tax Rate Due to a Change in Activities. Assume that Corporation A has all of its activities within New York and is a qualified New York manufacturer during its base year. Corporation A has no PNOLC subtraction pool. In 2020, Corporation A moves its manufacturing activities to Connecticut. Corporation A will no longer qualify for the reduced Tax rate and will now be subject to Tax on its income Tax base. Based on the Draft Regulations, Corporation A will not be entitled to a PNOLC subtraction in 2020—or any year after.

Should Corporation A instead be permitted to calculate a proforma PNOLC subtraction pool schedule and use the amounts that would otherwise be available for deduction, assuming it was never eligible for treatment as a qualified New York manufacturer? On one hand, we see no reason why a taxpayer that loses its status as a qualified New York manufacturer should be treated any worse than other New York taxpayers subject to the standard Tax rates. On the other hand, we can see a policy argument that considers the benefits that Corporation A previously received, and treats such benefits as requiring the foregoing of any PNOLC subtraction pool. 

2. The Reduced Tax Rate is No Longer Available to Taxpayers. Assume that Corporation A continues to meet the requirements to be treated as a qualified New York manufacturer. Based on a challenge to the constitutionality of the reduced rate, however, the reduced Tax rate is no longer available to any taxpayer, including Corporation A, beginning in 2020. Under this scenario, should Corporation A be permitted to compute a PNOLC subtraction pool to be used to offset its future income Tax liabilities?

Similarly, consider a situation in which, based on identical facts, Corporation A takes the reduced rate available to qualified New York manufacturers on its 2014 through 2018 Tax returns. The Department does not audit the reduced rate in 2014, but on audit of the 2018 return, rejects the interpretation that Corporation A’s activities qualify as “manufacturing.” Should Corporation A now be permitted to compute a PNOLC subtraction pool to be utilized in years in which a Tax liability exists?

As previously stated, neither the Tax law legislation nor the Draft Regulations acknowledge the potential quandary qualified New York manufacturers might face if they lose both the 0% rate and the ability to calculate a PNOL subtraction, and neither provide a mechanism to recapture a portion of the NOL subtraction pool that they forfeited by having a base year Tax rate of zero. The policy impact of this effect, however, is heightened when the unfavorable treatment of a taxpayer is the result of an unconstitutional law (or audit position taken by the Department), as opposed to the result of the taxpayer’s own decisions. It is possible that the Department contemplated this and chose to provide no relief; it is also possible that the implications—and a corresponding remedy—have not yet been contemplated and determined. Of course, a resolution to this issue could also come in the form of a remedy established by a New York court in order to provide meaningful relief to the taxpayers negatively impacted by this issue.

Limitations Imposed from the Draft Regulations’ Statute of Limitations

The Draft Regulations create statutes of limitations unique to the computation of the PNOLC subtraction pool and adjustments made to it based on federal changes. As currently drafted, the statute of limitations deviates from previous Department policy and creates limitations not otherwise provided for in the Tax law. 

The Draft Regulations (sections 3-9.2(e) and 3-9.6(c)) state that (i) any change in the amount of a taxpayer’s unabsorbed NOLs and (ii) any change in the base year tax rate or base year allocation percentage must be made within the statute of limitations under Tax Law section 1083(a) for the return on which the PNOLC subtraction pool is first reported, with regard to any extensions signed by the Department and the taxpayer. This policy pegs the computation of the PNOLC subtraction pool to the statute of limitations for each of its components (i.e., the tax rate, allocation percentage, and unabsorbed NOLs). 

Based on the Department’s interpretation, this will generally mean three years from the filing of the 2014 Tax return for tax rate and allocation percentage changes, and three years from the filing of the 2015 Tax return for changes to a taxpayer’s unabsorbed NOLs. The PNOLC, however, is not computed in the base year and instead is wholly determined on a separate form submitted as part of the first Tax return filed by a taxpayer under corporate Tax reform. By commencing the running of the statute of limitations for an adjustment to the base year tax rate or allocation percentage to the filing of the base year Tax return (instead of the filing of the form used to compute the PNOLC subtraction pool), the Department is treating the PNOLC subtraction pool as being computed at the time of the filing of the base year return. It is not clear that the statute supports this interpretation. 

Under the Draft Regulations, the PNOLC subtraction pool will also become fixed after a certain period of time, rather than allowing adjustments to be made (in the taxpayer or the Department’s favor) that affect only Tax years otherwise open for assessment or refund. This policy is different than the approach previously taken by the Department with regard to pre-Tax reform NOL schedules. The Department historically permitted adjustments to be made to NOLs in closed taxable years, so long as the increased NOL deduction was made in a year when the statute of limitations was otherwise open. In a similar vein, the Department has historically allowed a taxpayer’s workday allocation to be recomputed, even after the tax year is closed, when the allocation has an effect on a stock option allocation in an open tax year. While we recognize that the personal income tax is governed by statutes different than those at issue under the Tax, the statutes providing limitations on assessments, credits and refunds are substantially similar. The Draft Regulation leaves us curious as to whether the Department will also effect a change of policy in regard to post-tax reform NOLs.

The Draft Regulations (section 3-9.2(e)) also state that any federal changes that are finalized after the above discussed statute of limitations will not be considered in the computation of unabsorbed NOLs. Put simply, federal changes will not impact a taxpayer’s PNOLC subtraction pool after the statute of limitations is otherwise closed. In some instances, this might benefit a taxpayer by eliminating the need to reduce unabsorbed NOLs due to an increase in the taxpayer’s federal taxable income. For every beneficial scenario, however, we can anticipate that a taxpayer will be harmed by losing the opportunity to increase its unabsorbed NOLs. 

We are highly suspect of the Department’s ability to enforce this rule, as applied to RARs, through regulation. A similar proposition cannot be found anywhere in the Tax law. In fact, the Tax law continues to explicitly state that federal changes must be reported to the Department within 90 days (120 days if filing a combined return) (New York Tax Law section 211(3)). If a taxpayer does not report these changes, the Department’s ability to assess tax for those years remains open indefinitely (New York Tax Law section 1083(c)(1)(C)). The Tax law makes no distinction between the effects of the federal change on the tax base, as compared to the taxpayer’s computation of its PNOLC subtraction pool. We question whether the Department can mandate this distinction via its Draft Regulations.

The Draft Regulations are a welcome addition in an effort to further understanding the calculation and use of the PNOLC subtraction. They, however, leave taxpayers wanting in certain areas and raise new questions in others. We remain hopeful that many of the outstanding issues will be addressed in the Department’s next iteration of draft regulations.

robertsR. Gregory Roberts, Esq., is a partner in Reed Smith LLP’s New York office. His practice focuses on the resolution of state and local tax controversies throughout the country. He has represented individuals and corporations in administrative and judicial forums throughout the United States. Gregg also has extensive experience in advising multistate and multinational corporations on the tax ramifications of complex business transactions and corporate restructurings. Gregg has extensive experience in matters involving corporate income and franchise taxes, personal income tax, employment taxes, sales and use taxes, and property taxes, with particular experience in handling Pennsylvania corporate income, utility, and property tax matters, and New York corporate sales and use and personal income tax matters.

Jennifer_WhiteJennifer S. White, Esq.
, is an attorney in Reed Smith LLP’s New York office. She advises clients on all aspects of state and local tax and has extensive experience with New York State and City residency planning and audit defense. Ms. White can be reached at or 212-521-5406

goveJeremy P. Gove, Esq., is an attorney in Reed Smith LLP’s New York office.  He advises clients on all aspects of New York state and local tax.  Mr. Gove can be reached at or 212-549-4249.

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