Alabama Ruling on NOL Limitation Presents Refund Opportunity for Taxpayers

The court determined that Alabama’s separate return limitation year rules permit the use of NOLs as long as they were generated while the entity was part of an Alabama affiliated group.

States generally follow the federal net operating loss (NOL) guidelines when applying them to state tax returns. However, specific nuances do exist in each state. For example, some states don’t permit the NOLs of a corporation that merged out of existence to be used by the surviving corporation. Other states may have slight variations on carryforward and carryback periods. Careful attention must be paid to state NOL treatment or else a taxpayer may lose the ability to benefit fully from those tax attributes.

In the context of federal consolidated returns, there is a limitation on the use of NOLs known as the separate return limitation year, or SRLY, limitation. Essentially, a SRLY limitation applies when a corporation has generated NOLs prior to becoming a member of a federal consolidated return. This can occur when a corporation with NOLs is acquired by another corporation or group of corporations, and as a result, the acquired corporation joins in the filing of the federal consolidated return with the acquiring corporation(s). The SRLY limitation provides that NOLs of a taxpayer that were generated prior to joining a federal consolidated return may only be used to offset the separate income of that taxpayer after it has joined the group. [1]

For example, assume Corporation A has $500,000 of NOLs through 2015, and then is acquired and joins a federal consolidated group, without any NOL carryforwards, as of 1/1/16. During the 2016 tax year, the consolidated group generates $500,000 of federal taxable income, of which $100,000 was separately generated by Corporation A. Under the SRLY limitation, Corporation A may only use $100,000 of its NOLs to offset its $100,000 of income. The remaining $400,000 of Corporation A’s NOLs are not allowed to be used to offset the remainder of the consolidated group’s income. Therefore, the consolidated group will report $400,000 of income after the NOL deduction, and Corporation A will still have $400,000 of NOL carryforwards that are subject to the SRLY limitation.

On Sept. 8, 2017, the Alabama Court of Civil Appeals issued a decision upholding an administrative law judge ruling that Alabama’s SRLY limitation did not apply in cases where the NOL was generated by a corporation in a year in which that corporation was a member of an “Alabama affiliated group” (AAG, as defined below), but prior to that corporation filing an Alabama consolidated return with such other members of the AAG. [2]

Coca-Cola Enterprises, Inc. (CCE) and two of its subsidiaries conducted business in Alabama, and each filed separate Alabama corporate income tax returns. Due to changes in Alabama law in 1998 and then again in 2001, Alabama permitted affiliates that were members of a federal consolidated group and that also had nexus in Alabama (i.e., defined as an AAG) to elect to file an Alabama consolidated return. CCE and its two subsidiaries elected to file an Alabama consolidated return beginning in 2007; however, prior to that year but during the years in which CCE and its two subsidiaries were members of the AAG, CCE generated NOLs. On the 2007 Alabama consolidated return, CCE offset the group’s income with NOLs that it generated from prior years. Alabama rejected the use of the NOLs, asserting that Alabama’s SRLY limitation prohibited use of the NOLs that were generated in years prior to the filing of an Alabama consolidated return.
Alabama’s SRLY limitation provides that:

If, in a taxable year before the corporation became a member of an Alabama affiliated group that has elected to file an Alabama consolidated return, the corporation incurred a net operating loss, the deductibility of the loss on the Alabama consolidated return shall be limited to only the amount necessary to reduce to zero the Alabama taxable income, calculated on a separate return basis, of the corporation that incurred the net operating loss. Except as provided in the preceding sentence, the separate return limitation year (‘SRLY’) rules contained in 26 U.S.C. § 1502 shall apply. [3]

CCE argued, and the Court agreed, that the wording of the statute does not limit the use of the NOLs as long as the NOLs were generated while the entity was a member of the AAG. In other words, Alabama’s SRLY limitation is based not on when a member joined in the filing of an Alabama consolidated group but rather when the member joined the AAG. Since CCE and its two subsidiaries were members of an AAG when CCE generated its NOLs, those NOL carryforwards were available for use by the AAG without limitation in years when the AAG filed an Alabama consolidated return.

This ruling is significant because it presents a refund opportunity for taxpayers. Unlike the federal SRLY limitation rules and those of some other states, Alabama’s SRLY limitation does not apply as long as the members of the consolidated return group were part of an AAG when the NOL was generated, whether or not an Alabama consolidated return was filed in that year.
Therefore, if a group of Alabama taxpayers filing an Alabama consolidated return interpreted Alabama’s SRLY limitation to apply like the federal SRLY limitation, the taxpayer may not have been using as much of its NOL as is permitted. Alabama amended consolidated returns could be filed for open years to claim additional NOLs, thereby generating refunds.

Aprio’s SALT team is experienced in understanding the nuances of state NOL rules so that you will maximize your benefit from these tax attributes. We constantly monitor these and other important state tax issues in order to assist you with your specific tax situation, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact  Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the October 2017 SALT Newsletter.

[1] IRS Reg. section 1.1502-21(c)(1).

[2] Alabama Department of Revenue v. Coca-Cola Refreshment, U.S.A., Inc. f/k/a Coca-Cola Enterprises, Inc., No. 2160412 (Ala. Ct. of Civ. App., Sept. 8, 2017).

[3] Ala. Code § 40-18-39(h).

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