Directive  Directive 12-3: Net Operating Loss Carryforward Transitional Rules for S Corporations and their Qualified S Corporation Subsidiaries

Date:	06/27/2012
Organization:	Massachusetts Department of Revenue
Referenced Sources:	Massachusetts General Laws

Corporate Excise/Personal Income Tax

 

Introduction:  This Directive sets forth how, for taxable years beginning on or after January 1, 2009, an S corporation seeking to determine its entity-level excise on net income under G.L. c. 63, §§ 32D, 39 is to calculate and apply the net operating loss (NOL) carryforwards that were generated in taxable years beginning before January 1, 2009 by its Qualified Subchapter S Subsidiaries (QSubs).  This Directive also explains, in the discussion section below, the relevant consequences of several statutory changes enacted in recent years with respect to the taxation of S corporations and their QSubs.  The term “loss” as used in this Directive refers only to those losses that are eligible for the NOL carry forward under G.L. c. 63, § 30.5.[1]

Issue:  For taxable years beginning on or after January 1, 2009, how does an S corporation calculate and take into account the NOL carryforwards that were generated by its QSubs in taxable years beginning before January 1, 2009? 

Directives:

Directive 1.  General principle; determining the allowable NOL to an S corporation that derives from its QSubs.  An S corporation subject to G.L. c. 63, §§ 32D, 39 filing its return for a taxable year beginning on or after January 1, 2009 is generally permitted to use a loss carryforward that was generated by its QSub in a prior taxable year, provided that the loss is attributable to a year that the subsidiary was a QSub of the same S corporation.  In determining the allowable NOL carryforward amount that the S corporation parent may use, a QSub is required to perform a calculation of income or loss for each taxable year beginning with the taxable year after the loss year, whether or not the QSub was subject to the income measure of the corporate excise under G.L. c. 63, §§ 32D(a)(ii), 39 for any such year.[2]  In performing this “carryforward calculation,” the loss is reduced by the QSub’s positive income amounts in succeeding taxable years for the five-year carryforward period authorized for the periods at issue under G.L. c. 63, § 30.5.  The method for performing the carryforward calculation is explained in the Discussion and Example, below.

Directive 2.  Specific rule applicable to taxable years beginning on or after January 1, 2009 and before January 1, 2010.  For taxable years beginning on or after January 1, 2009 and before January 1, 2010, an S corporation may generally use an allowable loss carryforward amount as described in Directive 1, consistent with the statutory rules for such years requiring NOLs to be carried forward on a pre-apportionment basis.[3]  The method for calculating the pre-apportionment allowable NOL carryforward amounts under this rule is explained in the Discussion and Example, below. 

Directive 3.  Specific rule applicable to taxable years beginning on or after January 1, 2010.  For taxable years beginning on or after January 1, 2010, an S corporation may use an allowable NOL carryforward amount as described in Directive 1, consistent with the statutory rules for such years requiring NOLs to be carried forward on a post-apportionment basis.[4]  The method for calculating the post-apportionment allowable NOL carryforward amounts under this rule is explained in the Discussion and Example, below.

Discussion:  

Background.  This Directive addresses certain consequences of a series of statutory changes that relate to the taxation of S corporations and their QSubs.[5] The first of these changes concerns the former taxation of QSubs at the entity level.  Prior to the effective date of St. 2003, c. 4, § 18 ― namely March 5, 2003 ― QSubs were treated as separate taxable entities only with respect to the non-income measure of the corporate excise and the minimum excise, under G.L. c. 63.  Between March 5, 2003 and until the effective date of St. 2008, c. 173[6] ― (generally effective for the first taxable year beginning on or after January 1, 2009[7]) ― QSubs were treated as separate taxable entities generally subject to the income measure of the corporate excise determined under G.L. c. 63, § 32D, in addition to the non-income measure and the minimum excise to which they had previously been subject.  During the period between 2003 and 2009, QSubs (as well as their S corporation parents) were required to pay tax on income determined under § 32D(a)(ii) when an S corporation and its QSubs (and any related entities with which the parent S corporation shared common ownership and was engaged in a unitary business) had gross receipts in a taxable year of at least $6 million.  See fn. 2.

Currently, as a consequence of a further statutory change, St. 2008, c. 173, S corporations and their QSubs are no longer treated as separate taxable entities, but consonant with federal law, are collapsed into a single taxpayer.  Thus, for taxable years beginning on or after January 1, 2009, the income, loss, deductions, and credits of a QSub are taken into account by the S corporation parent when the parent files its corporate excise return.[8]   See, e.g., 830 CMR 63.30.3. 

NOLs that were generated by a QSub may be carried forward to be used by the parent S corporation in some circumstances.  An S corporation that is subject to Massachusetts tax jurisdiction and potentially subject to the entity-level excise on its income determined under G.L. c. 63, §§ 32D, 39 may be eligible to carry forward a loss under the rules set forth at G.L. c. 63, § 30.5.[9]  A loss generated in a taxable year that begins prior to January 1, 2010, may be carried forward by an eligible corporation for a period of five taxable years.  See G.L. c. 63, § 30.5.[10]  Where it is consistent with the rules that apply to NOL carryforwards generally, an S corporation may use a loss carryforward that derives from a QSub that was generated during a taxable year beginning prior to January 1, 2009, if the loss was generated by the QSub in a taxable year in which it was a QSub of the same S corporation.  In addition, assuming that the S corporation may use a loss carryforward of its QSub, that loss carryforward must be further adjusted according to the following carryforward calculation. 

The carryforward calculation.  In order for an S corporation to use a loss carryforward that derives from a QSub that was generated during a taxable year beginning prior to January 1, 2009, the QSub must perform a carryforward calculation for all intervening taxable years, whether or not the QSub was subject to Massachusetts tax on its income under G.L. c. 63, § 32D(a)(ii) for any such taxable year.  For any intervening taxable year in which the QSub was subject to Massachusetts tax on its income under G.L. c. 63, § 32D(a)(ii) because its total receipts were $6  million or more, the loss or income that is to be included in the carryforward calculation is the actual Massachusetts net income amount before apportionment.   For any intervening year in which the QSub was not subject to the income measure as calculated under G.L. c. 63, § 32D(a)(ii), the entity must perform a pro forma calculation of its income or loss for that year, as if it had been subject to the income measure of the excise.  In performing the carryforward calculation, any loss carryforward amount must be reduced by the income that derives from a year after the year of generation of the loss.  This calculation must be performed for the QSub for each year until the QSub is no longer treated as a separate taxable entity under G.L. c. 63 or until the carryforward is fully depleted.  If the NOL carryforward is fully depleted by reason of the calculation, the S corporation is not entitled to use any of the QSub’s carryforward.

Pre-apportionment and post-apportionment carryforward rules.  As a result of another recent statutory change, there are two different rules for calculating the amount of an NOL that can be carried forward by corporations in general, one requiring such carryforwards to be calculated and applied on a “pre-apportionment” basis and one requiring such carryforwards to be calculated and applied on a “post-apportionment” basis.  For taxable years beginning before January 1, 2010, the generally applicable rule is that losses that were eligible for NOL carryforward treatment were to be carried forward on a pre-apportionment basis.  See fn. 3.

For taxable years beginning on or after January 1, 2010, when a corporation is allowed to carry forward an NOL under G.L. c. 63, § 30.5, the NOL is determined and carried forward on a post-apportionment basis.  See G.L. c. 63, § 30.5(e).  In making this calculation, the QSub must determine its loss or income for a given taxable year, and multiply the relevant amount by the apportionment percentage of the QSub for each such taxable year.

Proportionate use of NOL carryforward amounts.  An S corporation seeking to use an allowable loss carryforward of a QSub must determine the portion of the S corporation’s overall, available NOL carryforward deduction that is attributable to the losses generated by such QSub, broken down by the taxable years in which the underlying losses were generated.  Where the S corporation seeks to use loss carryforwards of more than one QSub, it must make this determination separately for each QSub.  Further, the S corporation must separately account for its own loss carryforwards.  In all cases, the general NOL carryforward ordering rule applies, such that the S corporation must first deduct the oldest available loss regardless of whether it was a loss generated by the S corporation or a QSub. 

In any taxable year in which the S corporation seeks to apply loss carryforwards that derive from losses incurred by both itself and one or more of its QSubs in a prior taxable year, and where the NOL deduction to be taken is less than the total NOL carryforward balance of those entities, the following rule applies.  The amount of the loss carryforward taken by the S corporation that is attributable to the individual entities for such prior taxable year is determined in proportion to the amount of each entity’s carryforward loss available from that prior taxable year, subject to the relevant pre-apportionment or post-apportionment rules, above.    

Reporting NOL carryforwards on a return.  Because QSubs are no longer treated as separate taxable entities in Massachusetts, the current state tax forms, particularly Form 355S, Schedule E-2, do not provide a place to break out the total loss carryforwards attributable to individual QSubs and to individual taxable years, nor do they provide a place to report the apportionment percentages of each QSub for the year or years that the original loss or losses were incurred.  An S corporation filing its return must separately calculate the losses attributable to its individual QSubs, breaking out such losses by year and applying the apportionment percentage of each QSub for each year.  The total figures should be reported on the S corporation’s tax form, in particular Schedule E-2, as a blended figure, as shown in the following example.

Example.  For each of the taxable years 2007-2010, S corporation S has three QSubs, A, B, and C.  For each of these taxable years each of the four corporations is a calendar year filer.  Assume that the corporations have no other losses other than as referenced in this example.  Also, assume that the corporations have no other affiliates, such that in taxable years 2009 and 2010, the corporations are not required to file a combined report (as for those years, S and its three disregarded QSubs are treated as a single entity).  In the 2007-2010 taxable years, S is subject to Massachusetts tax jurisdiction and subject to the income measure under G.L. c. 63, § 32D(a)(ii).  Also, in taxable years 2007 – 2008 all the business operations of the four corporations are conducted by the QSubs, such that S has no income or loss of its own for those years, but is subject to G.L. c. 63, § 32D(a)(ii) on account of the QSubs’ activities.  Assume that in the 2007 and 2008 taxable years, QSubs A, B, and C are subject to Massachusetts tax jurisdiction and properly calculate income or loss for each taxable year.  This example focuses particularly on the amount of the loss of each of the corporations that can be carried forward from prior taxable years.

In taxable year 2007, A generates a loss of $100,000 and has an apportionment percentage of 30%.  In taxable year 2008, A has $20,000 of income and deducts $20,000 of its 2007 carry-forward loss from its income.  As of taxable year 2009, A continues to carry forward an $80,000 loss from 2007.

In taxable year 2007, B generates a loss of $10,000, all of which is allocated to Massachusetts.  In taxable year 2008, all B’s net income is allocated to Massachusetts, and B generates a loss of $6,500.  B thus uses none of its 2007 loss carryforward in 2008.  B separately records the $6,500 loss attributable to 2008 and also carries that loss amount forward.  As of taxable year 2009, B continues to carry forward a $10,000 loss from 2007, as well as the separately recorded loss of $6,500 from 2008.  

In taxable year 2007, C generates a loss of $50,000, and has an apportionment percentage of 20%.  In taxable year 2008, C has $5,000 of income and deducts $5,000 of its 2007 carry-forward NOL from its income.  As of taxable year 2009, C continues to carry forward a $45,000 loss from 2007.

In taxable year 2009, as a result of the Massachusetts legislative change that generally made business entities’ filing classifications conform to their federal classification, S and its QSubs A, B, and C, are treated as a single entity, with S filing the Massachusetts corporate excise return.  S and its three QSubs collectively generate net income of $13,500 for 2009.  S is allowed to deduct losses incurred and carried forward from prior taxable years under G.L. c. 63, § 30.5.  S has no prior losses of its own, and thus may use the remaining NOL carryforwards of its QSubs.  In so doing, S must apply the general rules that the oldest carried-forward losses are taken first, and that losses from individual entities for each carryforward year are used in proportion to the total combined loss available from the same carryforward year. Therefore, S will apply the following calculation. 

A’s available loss carryforward amount from 2007 is $80,000.  That amount is divided by the total available loss carryforward amount from 2007 of each of the three QSubs A, B, and C, namely $135,000[11], to yield a percentage figure of .5926.  The net income of S for 2009, $13,500 is then multiplied by this figure.  The resulting number of $8,000 is the loss carryforward that S will apply taken from A’s 2007 loss carryforward amount. 

B’s available loss carryforward amount from 2007 is $10,000.  That amount is divided by the total available loss carryforward amount of each of the three QSubs from 2007, namely $135,000, to yield a percentage figure of .074. The net income of S for 2009, $13,500 is then multiplied by this figure.  The resulting number of $1,000 is the loss carryforward that S will apply taken from B’s 2007 loss carryforward amount.

C’s available loss carryforward amount from 2007 is $45,000.  That amount is divided by the total available loss carryforward amount of each of the three QSubs from 2007, namely $135,000, to yield a percentage figure of .333. The net income of S for 2009, $13,500 is then multiplied by this figure. The resulting number of $4,500 is the loss carryforward that S will apply taken from B’s 2007 loss carryforward amount.

In taxable year 2010, S generates income from which it is allowed to deduct losses incurred in prior years under G.L. c. 63, § 30.5.  S has no prior NOL of its own, and thus will use only the remaining NOL of its QSubs.  However, unlike for purposes of its 2009 taxable year computation, S must now convert its QSub’s NOL carryforwards from pre-apportionment carryforwards to post-apportionment carryforwards.  See G.L. c. 63, § 30.5(e).  There is sufficient income to S that in 2010 it is able to use all NOL amounts that have been carried forward by its QSubs.^[12]  The method for calculating the total QSub losses available to the S corporation that were generated in the QSub’s 2007 taxable year is:

 

	A	B	C	Total
2007 loss	($100,000)	($10,000)	($50,000)	($160,000)
2007 % to be apportioned or allocated to MA	30%	100%	20%
2008 loss used by QSubs	$20,000	$0	$5,000	$25,000
2009 remaining loss attributable to 2007 available to S corporation on a pre-apportionment basis	($80,000)	($10,000)	($45,000)	(135,000)
2009 loss used by S, attributable to its pre-apportionment QSub carry-forward losses	$8,000	$1,000	$4,500	$13,500
2010 remaining NOL available to S corporation on a pre-apportionment basis (interim step – see next step to determine amount of usable NOL)	($72,000)	($9,000)	($40,500)	($121,500)
2010 remaining NOL attributable to 2007 available to S corporation after applying the respective QSub’s 2007 apportionment percentage to convert pre-apportionment losses into post-apportionment losses	($21,600) [i.e. $72,000 * 30%]	($9,000) [i.e. $9,000 * 100%]	($8,100) [i.e. 40,500 *    20%]	($38,700)

Note on how to report the use of the post-apportionment losses:  Because Massachusetts no longer treats QSubs as separate taxable entities, the current state tax forms do not have a place to break out the figures as shown in the chart above.  Thus, a further step is needed to accurately report the above-stated results on the S corporation’s return.  For example, where S is able to deduct the total unused remaining amount of 2007 loss carryforwards attributable to A, B, and C in 2010 ― i.e., $38,700 ― the method for reporting this NOL in taxable year 2010 on the Form 355S, Schedule E-2, is to report the total NOL available as calculated in the chart above and to calculate a blended apportionment percentage for A, B, and C as follows:  divide the total post-apportionment NOL of A, B, and C, namely ($38,700) by the total pre-apportioned NOL of A, B, and C remaining in 2010, namely ($121,500), which results in the blended apportionment percentage of 31.85%.  This blended percentage should be reported on Form 355S, Schedule E-2 on lines 1d, 2d, and 3d.  This calculation of a blended apportionment percentage should not result in any change in the NOL carryforward amount from that which is calculated according to the steps in this Example shown above.  S will apply the above post-apportionment loss to S’s post-apportionment net income.  In the case where S has income that is less than the total NOL available and thus cannot use the full amount, the S corporation should perform the same calculation on the actual amount of NOL carryforward taken in the taxable year, determining the blended apportionment percentage for A, B, and C.  S must take a proportionate amount from the remaining NOL carryforward attributable to each entity.
 

 

/s/Amy Pitter
Amy Pitter
Commissioner of Revenue

 

AP:MTF:dt

June 27, 2012

DD 12-3

[1] All the general rules that apply for calculating an NOL and an NOL carryforward pursuant to Massachusetts law apply equally to S corporations and QSubs, including the rule that a capital loss is not an NOL and that a capital loss shall not be carried forward.  Cf. G.L. c. 63, § 30.5.   Financial institutions are not entitled to use an NOL carryforward.  See G.L. c. 63, § 1, definition of “net income.”  Similarly, utility corporations taxable under G.L. c. 63, § 52A are not eligible to use an NOL carryforward.

[2] As with S corporations subject to G.L. c. 63, § 32D, a QSub that was subject to the entity-level excise as calculated under G.L. c. 63, § 32D(a)(ii), (b)  was required to pay the income measure on the applicable income only if it, in the aggregate with certain affiliates, had total receipts of $6 million or more.  Note that this Directive does not apply to the income of an S corporation or of a QSub that is subject to tax at the entity-level for federal purposes, such as income derived from built-in gains, as such income cannot be offset by a NOL carryforward.  See 830 CMR 63.30.2(9)(d).

[3] There is an exception to this rule requiring an NOL to be calculated on a pre-apportionment basis that applies to an S corporation that was a member of a combined group for a taxable year beginning on or after January 1, 2009; in such cases the S corporation was required to use a carryforward NOL on a post-apportionment basis.  See generally 830 CMR 63.32B.2(8).  For the rules that govern the use of NOL carry forwards as applied on a pre-apportioned basis, see 830 CMR 63.30.2.

[4] See G.L. c. 63, § 30.5(e).

[5] This Directive does not focus on combined reporting within the meaning of G.L. c. 63, § 32B.  For the application of those rules to S corporations, see generally 830 CMR 63.32B.2.

[6] St. 2008, c. 173, the so-called “check the box” legislation, resulted in general conformity between federal and Massachusetts entity classification.  See 830 CMR 63.30.3.

[7] Note that there are special transitional effective periods that apply in certain cases.   See 830 CMR 63.30.3, “Entity Classification under St. 2008, c. 173.” 

[8] Because they are now fully disregarded as a separate taxable entity, QSubs are no longer separately subject to the non-income measure or the minimum excise.

[9] Where a net operating loss was originally generated by a QSub and the resulting NOL carry forward may be used by the QSub’s parent S corporation under the terms of this Directive, the NOL shall be treated as having been originally generated by and available to the S corporation for purposes of G.L. c. 63, § 32D.  See 830 CMR 63.30.3(4)(a)7.  Consequently, the use of the NOL carryforward by the S corporation parent is not dependent on a subsidiary's continued status as a QSub.  In the event of a sale or disposition of the QSub in a taxable year beginning on or after January 1, 2009, or in the event that the QSub no longer qualifies as a QSub and becomes taxable as a separate entity in a taxable year beginning on or after January 1, 2009, any such NOL carry forward attributable to the former QSub continues to be an NOL carryforward of the parent corporation, and not of the QSub.  

[10] For losses incurred in a taxable year beginning on or after January 1, 2010, the permitted carryforward period has been extended to 20 years.  St. 2010, c. 240, §§ 120, 206.  This change in the duration of the permitted carryforward period is not pertinent to the analysis in this Directive, which applies to losses generated by QSubs in years prior to the first taxable year beginning on or after January 1, 2009.

[11]  The breakdown of the individual remaining loss carryforward amounts from 2007 that add up to $135,000 is:  A, $80,000; B, $10,000; C, $45,000.

[12]  If S’s income in 2010 was insufficient to use all the carryforward NOLs, S would apply the same rule used in 2009, that the oldest carried-forward NOLs are taken first, and that losses from individual entities for each carry-forward year are used in proportion to the total combined loss available from the same carryforward year.