May an Article 32 banking corporation subject to IRC section 475 mark-to-market exclude from entire net income the later-year 'gains' that simply reverse prior-year unrealized losses which (because Article 32 has no NOL deduction) never reduced its bank tax?

Plain-English summary

Country Bank asked about the interaction of IRC section 475 (which, since 1993, requires dealers in securities -- including most banks -- to "mark to market," recognizing unrealized gains and losses each year) with the Article 32 bank franchise tax. The hardship it foresaw: in a down market a bank can recognize large unrealized losses (generating a federal NOL), and when the market recovers it must recognize gains measured from the depressed basis. Federally those gains are offset by the NOL carryforward -- but Article 32 allows no NOL deduction (section 1453(b)(3)), so the gains could be fully taxed even though the matching losses never reduced the bank tax. Could the bank adjust entire net income to exclude that income?

No. Article 32 entire net income starts from federal taxable income (section 1453(a)), subject only to the specific modifications in section 1453(b)-(k) and the regulations. None of those modifications addresses the section 475 mark-to-market method, and section 1453(b)(3) expressly forbids any NOL deduction. So the bank may not make any adjustment to exclude the recovery-year income; it reports the federal section 475 results as they are, with no carryforward relief.

What this means for you

Article 32 banks get no NOL deduction

Unlike the federal system (and unlike some other taxes), the bank franchise tax computes entire net income without any net operating loss deduction. Losses in one year do not carry forward to shelter income in a later year.

There is no special fix for section 475 timing

Section 475's mark-to-market is purely a federal timing mechanism; over the life of a security the totals match. But because Article 32 has no NOL deduction and no section 475 modification, the timing mismatch is not corrected for state bank-tax purposes.

Plan for the mismatch

A bank with large unrealized securities losses followed by a recovery can face Article 32 tax on "artificial" recovery-year gains that were never offset by the earlier "artificial" losses.

Common questions

Q: Can an Article 32 bank carry forward a net operating loss?
A: No. Section 1453(b)(3) bars any NOL deduction in computing entire net income.

Q: Is there a modification to undo section 475 mark-to-market for bank tax?
A: No. Article 32 contains no modification or adjustment for the section 475 method.

Q: So the recovery-year gains are fully taxed?
A: Yes, as included in federal taxable income, with no adjustment and no NOL offset.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 1451 (franchise tax on banking corporations); section 1455(a) (9% of entire net income)
- Tax Law section 1453(a) (entire net income equals federal entire taxable income, subject to modifications)
- Tax Law section 1453(b)(3) (entire net income computed without any NOL deduction)
- IRC section 475 (mark-to-market accounting required of dealers in securities; most banks are deemed dealers)
- 20 NYCRR 18-2.3, 18-2.4, 18-2.5 (entire net income modifications -- none addressing section 475)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1996.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a96_5c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-96 (5) C
Corporation Tax
February 28, 1996

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C950717A

On July 17, 1995, a Petition for Advisory Opinion was received from Country Bank, P.O.
Box 1230, Route 6, Carmel, New York 10512.
The issue raised by Petitioner, Country Bank, is whether a New York banking corporation
subject to the "mark-to-market' provisions for securities under section 475 of the Internal Revenue
Code ("IRC") is allowed to exclude certain income from entire net income for purposes of Article
32 of the Tax Law. The income in question is income, in taxable years after a loss year, resulting
from the mark-to-market rules on stock owned in the loss year to the extent that unrealized losses
resulting from those rules on the stock owned in the loss year did not reduce the amount of tax
imposed in the loss year.
Section 475 of the IRC was enacted in 1993 (P L 103-66) effective for taxable years ending
on or after December 31, 1993. It requires a mark-to-market accounting method for dealers in
securities. Most banks are deemed to be securities dealers for this purpose. As a result of this
enactment, unrealized gains or losses must now be recognized each taxable year based on the year­
end market values of each security being compared with its original basis for the first taxable year,
or substituted basis (opening market value) for securities held for more than one year. For the
taxable year that the security is sold, gain or loss is recognized as if the security had been sold for
its fair market value immediately before the disposition. The dealer will then adjust the amount of
any gain or loss subsequently realized, as the result of a disposition of the security, to reflect the
gains or losses previously recognized through the application of the mark-to-market rules.
The Petitioner believes that the provisions of section 475 of the IRC could create a hardship
for a bank because Article 32 of the Tax Law does not provide for a net operating loss ("NOL")
deduction. The problem arises where a bank has large unrealized security losses, generating a NOL
for a taxable year and the stock market recovers in subsequent years. The bank will be required to
recognize gains, calculated by using the prior year's low year-end market value as substituted basis
without being able to offset the "artificial" gain with the prior year's "artificial" loss that is allowed
for Federal income tax purposes through the Federal NOL deduction.
Section 475(a) of the IRC provides, as the general rule with respect to securities held by a
dealer in securities, that:
(1) Any security which is inventory in the hands of the dealer shall be included in
inventory at its fair market value.
(2) In the case of any security which is not inventory in the hands of the dealer and
which is held at the close of any taxable year–

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Corporation Tax
February 28, 1996
(A) the dealer shall recognize gain or loss as if such security were sold for its
fair market value on the last business day of such taxable year, and
(B) any gain or loss shall be taken into account for such taxable year.
Proper adjustment shall be made in the amount of any gain or loss subsequently
realized for gain or loss taken into account under the preceding sentence.
Section 475(c)(1) of the IRC provides that the term "dealer in securities" means a taxpayer
who–
(A) regularly purchases securities from or sells securities to customers in the ordinary
course of a trade or business; or
(B) regularly offers to enter into, assume, offset, assign or otherwise terminate
positions in securities with customers in the ordinary course of a trade or business.
The net result of the calculations, for Federal income tax purposes, is nothing more than a
timing difference since the economic gain or loss when the security is ultimately sold will be equal
to the net gains or losses reported each year based on year-end market values under section 475 of
the IRC.
Section 1451 of Article 32 of the Tax Law imposes, annually, a franchise tax on every
banking corporation for the privilege of exercising its franchise or doing business in New York State
in a corporate or organized capacity.
Section 1455(a) of the Tax Law provides that the basic tax is "[n]ine percent of the taxpayer's
entire net income, or the portion thereof allocated to this state, for the taxable year or part thereof."
Entire net income is defined in section 1453(a) of the Tax Law as "total net income from all
sources which shall be the same as the entire taxable income (but not alternative minimum taxable
income) ... which the taxpayer is required to report to the United States treasury department ...
subject to the modifications and adjustments hereinafter provided."
Section 1453(b) through(k) of the Tax Law and sections 18-2.3, 18-2.4 and 18-2.5 of the
Franchise Tax on Banking Corporations Regulations, provide for the modifications and adjustments
required by section 1453(a) of the Tax Law. Section 1453(b)(3) of the Tax Law provides that entire
net income shall be computed without the deduction of any NOL deduction for the taxable year
allowable for Federal income tax purposes. Further, under section 1453 of the Tax Law, there is no
modification or adjustment applicable to the "mark-to-market" accounting method required by
section 475 of the IRC.
Accordingly, pursuant to section 1453 (b) (3) of the Tax Law, banking corporations
are not allowed to claim a NOL carryforward, and there is no provision in Article 32 of

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Corporation Tax
February 28, 1996
the Tax Law to modify or adjust any gain or loss included in Federal taxable income pursuant to the
provisions of section 475 of the IRC. Therefore, Petitioner will not be allowed to make any
adjustments to entire net income, for any taxable year, to exclude income included in Federal taxable
income that is offset by a Federal NOL deduction that is attributable to the application of section 475
of the IRC.

DATED: February 28, 1996

NOTE:

DORIS S. BAUMAN
Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.