New Jersey clarifies new net operating loss rules

The New Jersey Division of Taxation recently issued a revised version of Technical Bulletin TB-94, discussing new net operating loss (NOL) deduction and carryover rules for separate return filers for tax years ending on and after July 31, 2019.¹ The Division also issued Technical Bulletin TB-95, discussing specific NOL rules for combined group filers as a result of New Jersey’s shift to mandatory combined reporting.² TB-94(R) provides guidance on the significant changes to NOL deductions for taxpayers filing separate returns for New Jersey Corporation Business Tax (CBT) purposes, while TB-95 addresses specific issues likely to be faced by taxpayers filing as part of a combined group, including the conversion of prior NOL (PNOL) carryovers from a pre-allocation to post-allocation basis, and the calculation of combined group post-allocation NOL deductions and carryovers.

Background 

On July 1, 2018, New Jersey enacted legislation making significant changes to the state’s CBT regime, including adopting mandatory combined reporting for tax years ending on or after July 31, 2019.³ The combined filing mandate applies to combined groups with common ownership, engaged in a unitary business, and having at least one member subject to the CBT.⁴ With New Jersey having its own state-specific NOL calculations, substantial modifications to the NOL deduction were also implemented. NOLs were calculated on a pre-allocation basis for tax periods ending prior to July 31, 2019.⁵ The tax reform law changed the calculation of NOL deductions and carryovers from a pre-allocation to post-allocation basis for tax years ending on and after July 31, 2019. The purpose of TB-94(R) and TB-95 is to provide additional guidance to taxpayers related to prior NOL conversion carryovers (PNOLCCs) and the utilization of NOLs in both a separate company return and a combined group filing context.

TB-94(R) – NOL guidance for separate return filers

TB-94(R) addresses several aspects of the new NOL regime specific to taxpayers filing separate returns for CBT purposes, and provides taxpayers with the statutory references for the concepts discussed in the bulletin. For tax years beginning in 2019 and thereafter, NOLs will be calculated on a post-allocation basis for taxpayers continuing to file on a separate company basis. For calendar year taxpayers filing a separate return for CBT purposes, any unused, unexpired pre-allocation NOL carryovers for losses incurred in tax years beginning prior to Jan. 1, 2019 (referred to as the unabsorbed portion of NOL or UNOL) must be converted to PNOLCCs before they can be utilized.⁶ This calculation is completed by taking the UNOL and multiplying it by the taxpayer’s “base year business allocation factor” (the Base Year BAF). The Base Year BAF is the allocation factor used for purposes of calculating the entire net income for the taxpayer’s last tax period ending prior to July 31, 2019.⁷ For calendar year filers, the Base Year BAF will be the allocation factor that was reported on the taxpayer’s Form CBT-100 for the tax period ending Dec. 31, 2018. Taxpayers must have filed CBT returns in the applicable tax years in order for NOLs and NOL carryovers to be converted to PNOLCCs.

Taxpayers will utilize a PNOL conversion worksheet to assist in the conversion of UNOLs to PNOLCCs.⁸ A taxpayer’s PNOLCC should be applied first to the earliest tax period that the loss is allowed to be carried, with the excess being carried and applied to later tax periods, if applicable. PNOLCCs have a carryforward period of up to 20 tax years following the year of the initial loss.⁹ Post-allocation NOLs created in tax periods ending on or after July 31, 2019, are also subject to a carryforward period of up to 20 tax years. Post-allocation NOLs arising from tax periods ending on or after July 31, 2019, can only be applied to allocated entire net income once a taxpayer has used all PNOLs available. It should also be noted that PNOLs cannot be used to increase a current year loss.

The Division revised TB-94 to clarify that inactive corporations having unused NOL carryovers from prior tax periods are permitted to use the allocation factor from the last tax period ending prior to July 31, 2019 for which the taxpayer was considered active for purposes of the CBT.

TB-95 – NOL guidance for combined return filers Similar to

TB-94(R), TB-95 provides taxpayers with statutory references and definitions for the key NOL terminology used in the bulletin. Taxpayers filing a combined return for CBT purposes must also convert any UNOL to PNOLCCs before they can be utilized.¹⁰ PNOLCCs for combined groups are calculated in a similar manner to separate return filers for CBT purposes. Combined group taxpayers will use specific forms to assist with the conversion calculation.¹¹ Taxpayers will need to report the Base Year BAF reported on Schedule J of the last separate return filed for the combined group’s managerial member and each separate member in addition to each member’s UNOL by tax year. The result of each member’s Base Year BAF multiplied by the UNOL for each privilege period is the converted NOL for each tax period on a post-allocation basis. The converted losses, or the PNOLCC, have a carryforward period of up to 20 tax years following the year of the initial loss.¹²

Similar to separate return filers, once a member’s PNOLCC is determined, the PNOLCC should be applied first to the earliest tax period that the loss is allowed to be carried. The excess should then be carried and applied to later tax periods, if applicable. TB-95 further clarifies that PNOLCCs calculated for a separate member can only be used to offset the allocated entire net income of the member that generated the PNOLCC. NOLs incurred prior to the combined reporting mandate cannot be shared with other members of the combined group. Further, post-allocation NOLs arising from tax periods ending on or after July 31, 2019, can only be applied once a member has used all of its available PNOLCC. As previously noted in the context of separate filings, PNOLs cannot be used to further increase a loss in the current year. If the combined group reports a loss during the tax year, the members of the combined group may not use the PNOLs.

TB-95 specifies that post-allocation NOLs incurred by a taxable member of a combined group for tax periods beginning on or after July 31, 2019, may be used to offset the income of any member that was included in the combined group during the period the NOL was generated. If a taxable member joins a combined group and has previously incurred NOLs for periods in which it was not part of that established combined group, the NOLs can only be used to offset that specific member’s income, or the income for any members that were in the same combined group in the year the loss occurred.¹³ Combined group members are instructed to keep accurate books and records to prevent the double use of post-allocation NOL carryovers.

For combined groups filing on a water’s-edge or worldwide basis, in the event that a member of the combined group is considered to have business activities that are independent of those performed within the group, the member should utilize Schedule X of Form CBT-100U to report the income on the basis of its independent activities. This member will be considered a “partially included member” and any post-allocation NOLs incurred by the member are considered separate from the combined group. In contrast, there will be no separate activity NOLs and NOL carryovers for elective affiliated group filers, unless a taxpayer becomes a regular member of the affiliated group at a later date.

Discharge of indebtedness income and NOLs

The Division provides specific guidance for taxpayers recognizing discharge of indebtedness. Modifications are necessary if certain categories of debt cancellation were excluded from a taxpayer’s federal taxable income. A taxpayer must reduce its current post-allocation NOL by its allocated discharge of indebtedness income if a loss is incurred in the same tax year in which a discharge of indebtedness occurs. This amount is calculated by multiplying the discharge of indebtedness income by the taxpayer’s current year allocation factor. If the allocated discharge of indebtedness exceeds the current year post-allocation NOL, taxpayers must first reduce their PNOLs, if applicable, subsequently followed by any previously generated post-allocation NOL carryovers.

Additionally, a taxpayer having allocated entire net income in the same tax year as a discharge of indebtedness must reduce any PNOLs or post-allocation NOLs that are being utilized by its allocated discharge of indebtedness income. The taxpayer’s allocated discharge of indebtedness income is calculated using the taxpayer’s current year allocation factor. Similar to above, if the allocated discharge of indebtedness amount exceeds all of the taxpayer’s PNOLs or if no PNOLs remain, the taxpayer must then reduce its post-allocation NOL carryovers. The remaining balance of NOL carryovers can then be utilized to offset the taxpayer’s allocated entire net income.

Commentary

While the concept of combined reporting is new for purposes of the CBT, other states have experienced similar transitions to mandated combined group filings. New Jersey’s calculation of a taxpayer’s PNOLCC is comparable to New York’s conversion guidance when the state shifted to combined reporting for tax years beginning on or after January 1, 2015.¹⁴ Prior to moving to mandatory combined reporting, NOLs for purposes of the New York corporation franchise tax were determined on a pre-apportionment basis. For tax years beginning on or after January 1, 2015, New York NOLs are determined on a post-apportionment basis.¹⁵ Taxpayers were required to calculate their prior NOL conversion in a similar manner as outlined by the Division, by utilizing the taxpayer’s base year allocation percentage to compute the value of the taxpayer’s unused, unexpired NOL.¹⁶ While New York tax law required an additional calculation to determine the “conversion subtraction pool,” many of the implications for taxpayers moving to a combined group filing were the same.

As CBT taxpayers transition from separate company to mandatory combined reporting in New Jersey, the bulletins issued by the Division continue to provide helpful guidance. As with other New Jersey tax reform topics, the Division expects to release formal regulations related to the NOL changes addressed in the bulletins. Taxpayers should carefully consider the implications of the NOL changes, especially taxpayers in a loss position or having NOL carryforwards needing to be converted to PNOLCCs. Since the value of the PNOLCCs is dependent upon the Base Year BAF, taxpayers should closely examine the calculation of the BAF during the 2018 tax year, as it will directly impact the value of future NOLs. An analysis of the Base Year BAF should be completed before reporting any converted NOLs on the 2019 CBT return. Because New Jersey decouples from federal NOL rules, the recent changes to the NOL deduction limitation and carryback provisions of the CARES Act do not currently impact the specific guidance discussed in the bulletins.

The calculation of converted NOLs may have significant implications for service businesses whose New Jersey allocation factors will be impacted by the shift from cost-of-performance to market-based sourcing for sales of services beginning with the 2019 tax year.¹⁷ For example, a taxpayer having a high New Jersey allocation factor in 2018 under a cost-of-performance sourcing methodology may have significant PNOLs, but may have a lower allocation factor under market-based sourcing. The transition to market-based sourcing may significantly impact the ability to prospectively utilize converted NOLs, and therefore may require the application of a valuation allowance for financial accounting purposes. Additionally, taxpayers that recognized repatriation income under IRC Sec. 965 are likely to have reduced PNOLs available for conversion. New Jersey considers Sec. 965 income to be a deemed repatriation dividend subject to a partial dividends received deduction after the application of PNOLs.¹⁸ Impacted taxpayers likely saw a reduction of available PNOLs prior to the 2018 tax year, potentially impacting the amount available for conversion.

Finally, New Jersey law generally limits the carryover of NOLs to the corporation actually incurring the loss and prohibits acquiring corporations from using NOL carryovers attributable to acquired corporations.¹⁹ While the 2018 tax reform legislation clarified that this prohibition does not apply between members of a combined group that are included on a combined return in the case of post-allocation NOLs,²⁰ the statute does not provide a similar prohibition for PNOLs.²¹ Further, TB-95 does not specifically address the impact of the law change on PNOLs in the context of a change of ownership. Based on the difference in statutory language, it is possible that the Division will disallow the conversion of a PNOL carried over by an entity acquired by a combined group, an area ripe for further litigation.

1 N.J. Technical Bulletin TB-94(R), General Information on the New Net Operating Loss Regime for Tax Years Ending on and After July 31, 2019, N.J. Division of Taxation, revised Feb. 18, 2020.
2 N.J. Technical Bulletin TB-95, Net Operating Losses and Combined Groups, N.J. Division of Taxation, Feb. 18, 2020.
3 P.L. 2018, c. 48; P.L. 2018, c.131, Laws 2018. For a detailed analysis of New Jersey’s 2018 tax overhaul, see GT SALT Alert: New Jersey Enacts Major Legislation Adopting Mandatory Combined Reporting, Market-Based Sourcing.
4 N.J. REV. STAT. §§ 54:10A-4(z); 54:10A-4.6.
5 N.J. REV. STAT. § 54:10A-4(k)(6).
6 General Instructions for Corporation Business Tax Return and Related Schedules, Form CBT-100 – 2019, N.J. Division of Taxation.
7 N.J. REV. STAT. § 54:10A-4(u)(1).
8 Worksheet 500-P, New Jersey Corporation Business Tax Prior Net Operating Loss Conversion Worksheet. While Worksheet 500-P and its corresponding instructions were initially intended for informational purposes, the worksheet must be enclosed with a taxpayer’s CBT return going forward to substantiate the use of converted PNOL carryovers for tax periods ending on or after July 31, 2019.
9 N.J. REV. STAT. § 54:10A-4(u)(2)(B).
10 General Instructions for Corporation Business Tax Unitary Return and Related Schedules, Form CBT-100U – 2019, N.J. Division of Taxation.
11 Form 500U-P, Prior Net Operating Loss Carryovers (PNOL) For Tax Periods Ending PRIOR TO July 31, 2019. Form 500U-P must be enclosed with a taxpayer’s CBT return to substantiate the use of converted PNOL carryovers for tax years ending on or after July 31, 2019.
12 N.J. REV. STAT. § 54:10A-4(u)(2)(B).
13 Post-allocation NOLs should be reported on Form 500U-PA, Post Allocation Net Operating Loss Carryovers (NOL) For Tax Periods Ending ON AND AFTER July 31, 2019. Post-allocation NOLs that are ultimately shared between members of a combined group are then reported on Form 500U-S, for which the taxpayer calculates the allowable shared NOL deduction.
14 N.Y. TAX LAW § 210-C.
15 N.Y. TAX LAW § 210.1(a)(ix).
16 N.Y. TAX LAW § 210.1(a)(viii).
17 N.J. REV. STAT. § 54:10A-6(B)(4)(i).
18 N.J. REV. STAT. §§ 54:10A-6.5; 54:10A-4(k)(5); Notice: New Jersey’s Treatment of Deemed Repatriation Dividends Reported Pursuant to Internal Revenue Code (IRC) Section 965, N.J. Division of Taxation, Mar. 16, 2018.
19 Richard’s Auto City, Inc. v. N.J. Division of Taxation, 659 A.2d 1360 (N.J. 1995).
20 N.J. REV. STAT. §§ 54:10A-4.5(b); 54:10A-4(v)(5).
21 See N.J. REV. STAT. § 54:10A-4(k)(6)(D) (“Where there is a change in 50% or more of the ownership of a corporation…no net operating loss sustained before the changes may be carried over to be deducted from income earned after such changes”).