June 8, 2018
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek the correction of the individual income tax assessment issued to your clients, ***** (the “Taxpayers”), for the taxable year ended December 31, 2011. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayers incurred a net operating loss (NOL) in the 2009 taxable year. For federal income tax purposes, the Taxpayers carried back the 2009 net operating loss deduction (NOLD) to the 2004 taxable year. Because Virginia does not conform to this federal five-year NOLD carryback rule, the Taxpayers carried the 2009 NOLD back to the 2007 taxable year. The entire amount of the NOLD was not used in 2007 and none of the remainder was utilized in 2008 because the Taxpayers incurred a loss in that year. Therefore, the Taxpayers carried the 2009 NOLD forward and claimed subtractions for it on their 2010 and 2011 Virginia income tax returns.
Under audit, the Department disallowed the subtraction for the NOLD on the 2011 return and issued an assessment. The Taxpayers appealed, contending the return properly accounted for the 2009 NOLD carried forward for Virginia income tax purposes.
DETERMINATION
Net Operating Loss Computation
Virginia income tax laws do not address the computation of NOLs. Nonetheless, Virginia Code § 58.1-301 provides 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), with certain exceptions, unless a different meaning is clearly required. For individual income tax purposes, Virginia generally conforms to federal law in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI).
Thus, before an individual may claim an NOLD, they must first determine if they have a NOL for federal income tax purposes. For a given taxable year, an individual may have an NOL if FAGI is a negative amount after subtracting the standard deduction or itemized deductions. To determine if an individual has an NOL and the amount of such NOL, the negative amount must be adjusted to eliminate any deduction for personal exemptions, capital losses in excess of capital gains, IRC § 1202 exclusions of the gains from the sale or exchange of qualified small business stock, nonbusiness deductions in excess of nonbusiness income, any NOLD carry over from another taxable year, and any domestic production activities deduction. See IRS Pub 536 for more information concerning computing an NOL for federal income tax purposes.
Further, because Virginia does not fully conform to the IRC, the NOL must be further adjusted to determine if the individual has a federal NOL for Virginia income tax purposes. In 2003, Virginia began conforming to the IRC as of a specific or fixed date. Since then the General Assembly has enacted legislation to move the fixed date forward each year. Effective for taxable years beginning on and after January 1, 2011, Virginia's fixed-date of conformity was advanced from December 31, 2010, to December 31, 2011, with limited exceptions. See Virginia Tax Bulletin (VTB) 12-1 (2/9/2012). For the 2011 taxable year, Virginia continued to: (1) prohibit bonus depreciation allowed for certain assets under IRC § 168(k); (2) exclude income tax deductions related to applicable high yield discount obligations under IRC § 163(e)(5)(F); (3) limit the domestic production deduction allowed under IRC § 199 to 6% of the qualifying income; and (4) disallow the 5-year carry-back allowed for certain NOLs.
Fixed date conformity additions and subtractions, therefore, are not considered to be Virginia modifications. Rather, these exceptions identified in Virginia Code § 58.1301 are added to or subtracted from FAGI as computed under the IRC in order to determine an individual taxpayer's FAGI for Virginia income tax purposes. In order to compute the federal NOL allowed for Virginia income tax purposes, an individual would need to make either negative or positive adjustments for the bonus depreciation, high yield discount obligations, and domestic production deduction conformity modifications related to items included in the computation of the NOL on the federal return. In addition, as with the computation of a federal NOL, any fixed date NOLD addition or subtraction carried over to the current taxable year would be excluded from the federal NOL (FNOL) computation for Virginia income tax purposes. An individual's Virginia federal NOL (VAFNOL) would be calculated by starting with the FNOL as reported on the federal income tax return, adding applicable fixed date conformity additions (AFDCA) and the subtracting applicable fixed date conformity subtractions (AFDCS). The formula for determining Virginia FAGI would then be as follows:
FNOL + AFDCA - AFDCS = Virginia FAGI
For Virginia income tax purposes, an individual taxpayer will have an NOL only if the formula results in a Virginia FAGI that is less than zero. If AFDCA exceeds the total of a FNOL plus AFDCS, the individual taxpayer will not have an NOL. Conversely, if AFDCS exceeds FNOL plus AFDCA, the taxpayer may have an NOL for Virginia income tax purposes even if they do not report an NOL on their federal return.
Net Operating Loss Deduction
Generally, IRC § 172(b)(1)(A) permits NOLs to be carried back two years and carried forward 20 years from the year of loss. Taxpayers may, however, elect to forego the NOL carryback pursuant to IRC § 172(b)(3). Unless such an election is made, the NOL must first be carried back to the earliest of the carryback years. See Public Document (P.D.) 88-106 (5/12/1988) and P.D. 93-83 (3/26/1993). The resulting NOLD, to the extent it exceeds taxable income for the taxable year to which it is carried, is carried forward to the next earliest taxable year in chronological order until it is completely absorbed.
Pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-110-84, Virginia allows federal NOLDs to the extent that they are included in computing FAGI. Generally, an NOLD cannot exceed the amount of the FAGI for the taxable year to which it is carried. As such, the FAGI reported on a Virginia income tax return cannot be less than zero for a taxable year in which a taxpayer is claiming an NOLD.
Virginia NOLD Modification
Under Title 23 VAC 10-110-82, certain modifications must be made to any item that is a component of the federal NOLD. The net result of these modifications, which relates to the loss year, follows the federal NOL to the taxable year in which the loss is utilized. The Virginia NOLD modification applies in the same proportion as the amount of NOLD that is used. Title 23 VAC 10-110-83 contains examples of how to calculate the Virginia NOLD modification and includes model worksheets.
Title 23 VAC 10-110-82 C provides that there is a positive modification for the items listed in Virginia Code § 58.1-322 B and a negative modification for the items listed in Virginia Code § 58.1-322 C. In addition, there are modifications for beneficiaries in Virginia Code § 58.1-322 E, and for transitions in Virginia Code § 58.1322 F. In addition, there is a negative deduction for blind or aged taxpayers under Virginia Code § 58.1-322 D 2. Finally, there is a positive modification for the state income tax deduction and a negative modification for the additional charitable mileage deduction specified in Virginia Code § 58.1-322 D 1. There is, however, no modification for a taxpayer's personal exemption.
In 2017, the General Assembly recodified Virginia Code § 58.1-322. See Chapter 444, Acts of Assembly. As a result, additions can now be found under Virginia Code § 58.1-322.01 (formerly § 58.1-322 B), subtractions now appear under Virginia Code § 58.1-322.02 (formerly § 58.1-322 C), deductions are now included under Virginia Code § 58.1-322.03 (formerly § 58.1-322 D), and additional modifications are set forth under Virginia Code § 58.1-322.04 (formerly § 58.1-322 E and F).
The net amount of the Virginia NOLD modification to be applied to the carryback or carryforward year must be reported on the Virginia return corresponding to such carryback or carryforward year as a separate Virginia addition to, or subtraction from, FAGI, as the case may be. If the Virginia NOLD modification addition exceeds the amount of the NOLD, the modification addition would be reduced to equal the amount of the NOLD. The resulting effect of any carryover would result in no net change to the tax liability for the taxable year to which it is carried, but must be reported in order to correctly adjust the FAGI for that taxable year. Failure to report such a carryover could result in issues with subsequent federal adjustments or NOLDs from other taxable years.
Reporting an NOLD
An individual cannot simply apply the amount of a federal NOLD to the FAGI in a carryover year. To determine the amount of the NOLD that can be deducted, the individual must determine the amount of income that could be offset on their federal return for the carryover year and then adjust that amount to account for Virginia fixed date conformity additions and subtractions. Only after making such adjustments to FAGI can an individual determine what portion of the NOLD may be used in the carryover year for Virginia income tax purposes.
As indicated above, an NOL can be carried back and forward in accordance with the rules established under IRC § 172, except for the five-year carryback allowed under IRC § 172(b)(1)(H). See Virginia Code § 58.1-301 B 2. Accordingly, a taxpayer must report the difference between the amount of the NOLD claimed on a federal income tax return and the amount usable for Virginia income tax purposes as a fixed date conformity adjustment.
The fixed date conformity adjustment would include both the NOL carryover and any adjustment to itemized deductions as required for federal income tax purposes. In addition, because the Virginia NOLD modification must be applied with the NOLD, individuals must also report the applicable amount as an addition or subtraction. Although, individuals have reported the Virginia NOLD modification on Virginia Schedule ADJ (Form 760-ADJ), it would be properly reported as a fixed date conformity addition or subtraction.
A separate schedule should be attached to the Virginia return to reconcile the amount of the NOLD used to the amount of the NOL carried over. In addition, taxpayers should attach a worksheet to the return showing the computation used
to calculate Virginia NOLD modification amount.
Taxpayer's Computation
The Taxpayers subtracted the entire amount of the NOLD directly from FAGI on their 2011 Virginia return, resulting in a negative balance contrary to Virginia policy. As indicated above, the amount of the 2009 NOLD that can used in the 2011 taxable year would be limited to a proportion after adjusting for fixed date conformity additions and subtractions. In addition, it appears that the Taxpayers computed their NOL carrybacks and carryovers without regard to the Virginia NOLD modification.
CONCLUSION
In accordance with Virginia's policy as set forth above, the 2011 Virginia income tax return did not properly report the NOLD. The evidence however indicates the Taxpayers could have claimed an NOLD for a portion of the 2009 NOL in the 2011 taxable year.
With their appeal, the Taxpayers provided a schedule showing a fixed date conformity calculation. The documentation, however, is not sufficient to determine the proper amount of the NOLD. It is recommended, therefore, that the Taxpayers amend their 2011 Virginia return, ensuring that the appropriate schedules and worksheets are attached in accordance with this determination. In addition, the Taxpayers may also wish to examine any other Virginia returns on which they reported a NOLD and file amended returns as appropriate.
The 2011 amended return should be submitted within 30 days from the date of this letter to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attention: *****. Upon receipt, the return will be reviewed and processed, and the assessment will be adjusted as warranted. If the return is not received within the time provided, the assessment will be adjusted based on the information available and collection action will resume.
The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1083.B