How does a Texas business-loss carryforward work for the franchise tax, and must a corporation use the loss in a year when it already owes no tax?

Plain-English summary

A corporation asked how the Texas franchise-tax business-loss carryforward works, and whether it has to use a loss in a year when it already owes no tax. The Comptroller walked through the rules and two worked examples.

• No deduction for a federal NOL. Earned surplus starts from federal taxable income before net operating loss deductions (Sec. 171.110(d)), and Texas gives no deduction against earned surplus for a federal NOL.
• But a "business loss" is deductible. Sec. 171.110(a)(4) allows a deduction for a business loss - defined by Sec. 171.110(e) as "any negative amount after apportionment and allocation" - which must be carried forward five years or until exhausted, whichever is first.
• You must use it each succeeding year. Under Rule 3.555(g)(2), a carried-forward loss "must be applied to the extent of apportioned plus allocated taxable earned surplus in that succeeding year." So a profitable year consumes the loss even when the corporation owes no tax because gross receipts are under $150,000 or the computed tax is under $100 - the no-tax-due threshold has no bearing on using a loss (Sec. 171.002(d)(2)).
• The examples.
  • Example 1: $40,000 loss (1999) + $10,000 loss (2000) = $50,000 carried to 2001.
  • Example 2: $40,000 loss (1999) then $10,000 profit (2000) = $30,000 carried to 2001.
• Practical filing tip. A corporation may want to file the long form to preserve or add to a loss carryover even if it qualifies for the short form and owes no tax. No worksheet has to be attached, but keep one to substantiate the carryforward if audited.

Currency note: This 2000 letter applies the pre-2008 franchise tax and its earned-surplus business-loss rules (replaced by the margin tax effective January 1, 2008 under House Bills 3 and 3928). The margin tax handles losses differently and pre-2008 carryforwards did not generally carry over; confirm current law.

What this means for you

Small corporations that owe no franchise tax

Owing no tax did not let you "bank" a loss for later - a later profitable year still used up the loss automatically. To keep a loss available across years, the practical move was to file the long form and track the carryforward, then apply it in each succeeding year as the rule requires.

Tax professionals

The letter draws the line between a federal NOL (not deductible against earned surplus) and a Texas business loss (deductible, five-year carryforward). Two operational points travel: the loss must be applied in each succeeding earned-surplus year (Rule 3.555(g)(2)), and the no-tax-due thresholds in Sec. 171.002(d)(2) do not suspend that. Substantiate carryforwards with a retained worksheet. Re-verify everything under the margin tax, which does not use this framework.

Common questions

Q: Can I deduct my federal net operating loss against Texas earned surplus?
A: No. Earned surplus starts before the federal NOL deduction. Texas instead allows a "business loss" - a negative amount after apportionment and allocation - with a five-year carryforward.

Q: If I owe no franchise tax this year, can I save my carryforward for later?
A: No. Under Rule 3.555(g)(2) the loss must be applied against that year's apportioned plus allocated earned surplus. The no-tax-due thresholds (under $150,000 receipts or under $100 tax) do not change that.

Q: Do I have to attach a worksheet showing the loss?
A: No attachment is required, but keep a worksheet to substantiate your loss carryforwards in case of audit.

Citations and references

Statutes and rule:

• Texas Tax Code Sec. 171.110(d) - earned surplus begins with federal taxable income before net operating loss deductions
• Texas Tax Code Sec. 171.110(a)(4) - deduction for a business loss
• Texas Tax Code Sec. 171.110(e) - business loss is any negative amount after apportionment and allocation; five-year carryforward
• Texas Tax Code Sec. 171.002(d)(2) - the no-tax-due thresholds do not bar use of a business loss
• 34 Tex. Admin. Code Sec. 3.555(g)(2) (Franchise Tax Rule 3.555) - a carried-forward loss must be applied in the succeeding year

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200009123L

Original ruling text

September 28, 2000

To: ****

Dear ****:

Thank you for your e-mail regarding the business loss carryover for Texas
franchise tax reporting purposes.

As you know, under the Texas Tax Code (TTC) Section 171.110(d), the beginning
point for computing earned surplus is the corporation's "federal taxable income
after Schedule C special deductions and before net operating loss deductions as
computed under the Internal Revenue Code." Texas franchise tax law does not
permit a deduction against earned surplus for a federal net operating loss.

TTC Section 171.110(a)(4) does, however, allow for a deduction of a business
loss, which is defined in TTC Section 171.110(e) as "any negative amount after
apportionment and allocation." TTC Section 171.110(e) provides that a business
loss must be carried forward five years or until the loss is exhausted
whichever occurs first.

Franchise tax rule 3.555(g)(2) states that "a business loss which is carried
forward to a successive year must be applied to the extent of apportioned plus
allocated taxable earned surplus in that succeeding year." Even though the
taxpayer will owe no franchise tax, they must use the loss from a prior year to
offset the current year's apportioned plus allocated taxable earned surplus.

Based on the information in the TTC and the rule, a corporation may want to use
the long form franchise tax report to preserve a business loss carryover, or
add to it, even if they qualify to file a short form report and will owe not
tax.

The fact that no tax is due because the corporation's gross receipts from its
entire business for both taxable capital and earned surplus are each less than
$150,000 or the corporation's calculated tax liability is less than $100 has no
bearing on the use of a business loss. See Section 171.002(d)(2).

I have restated your specific examples below along with my responses:

Example 1:
Year 1999 had a $40,000 business loss (filed long form).
Year 2000 had a $10,000 business loss (filed short form).

For year 2001 what is the available business loss carried to that year?

Response:
The taxpayer would have $50,000 in business losses to carry forward to the 2001
franchise tax report.

Example 2:
Year 1999 had a $40,000 business loss (filed long form).
Year 2000 had a $10,000 business profit (filed short form).

For the year 2001 what is the available business loss carried to that year?

Response:
The taxpayer would have $30,000 in business losses to carryforward to the 2001
report.

You also asked if the answer is something other than zero would it be necessary
to attach a worksheet to the 2001 report if you use the business losses. No,
an attachment to the report will not be necessary; however, you should keep a
worksheet to substantiate your loss carryforwards in case you are ever audited.

The statutory cites and the rule mentioned above may also be viewed via the
Comptroller's website. Once you are on the home page, click on the heading
"Texas Taxes", then on "The Franchise Tax." You'll see links to "Chapter 171
of the Tax Code."

This response is based on current law and the facts presented. If there are
different or additional facts, the response may change.

If you have questions about this, my internet address is
, or you may call toll-free at 1-800-531-5441,
extension 3-4612.

Sincerely,

Janet Spies
Tax Policy Division
Texas State Comptroller