When a subsidiary with federal NOLs liquidates into its parent, do the losses carry over to the parent for Texas franchise tax?

Plain-English summary

A taxpayer described a restructuring and asked whether a subsidiary's losses carry over to the parent for Texas franchise tax. The facts: a Texas corporation P bought all the stock of another Texas corporation S (which had unused federal NOLs); in a complete liquidation, S transferred all its assets to P with non-recognition under IRC Sections 332 and 337, and under IRC Section 381 P succeeded to S's federal tax attributes, including the NOLs. The Comptroller's answer was no for franchise tax, for two independent reasons.

• Federal NOLs never enter the earned-surplus base. Tax Code Sec. 171.110(d) excludes federal net operating losses from reportable federal taxable income, which is the starting point for net taxable earned surplus under Sec. 171.110(a). So even though P inherited S's NOLs federally, those NOLs do not reduce the Texas earned-surplus base.
• A franchise business loss cannot be transferred by merger. Sec. 171.110(e) provides for a franchise-tax business loss and its carryforward, but Franchise Tax Rule 3.555(g)(3) states: "A corporation may not convey, assign, or transfer a business loss to another entity including, but not limited to, by merger." Consequently, any business loss of S does not carry over to P.

Currency note: This letter describes the pre-2008 franchise tax and its earned-surplus business loss (replaced by the margin tax effective January 1, 2008 under House Bills 3 and 3928). The current tax treats losses differently; confirm present law.

What this means for you

Companies acquiring or absorbing a loss subsidiary (pre-2008)

Federal loss-succession rules (IRC 332/337/381) did not carry a target's losses into the parent's Texas franchise tax. Federal NOLs were excluded from the earned-surplus base to begin with, and any Texas "business loss" was non-transferable - even in a merger or liquidation. Do not price a target's Texas loss carryforwards into a stock-purchase-and-liquidation deal.

Tax professionals structuring reorganizations

Rule 3.555(g)(3) is categorical about mergers. Pair this with the general business-loss rules in the companion letter 200204957L (forward-only, non-transferable) when advising on Texas loss usage after a combination.

Common questions

Q: Did the parent inherit the subsidiary's federal NOLs for Texas franchise tax?
A: No practical benefit - Sec. 171.110(d) excludes federal NOLs from reportable federal taxable income, the starting point for net taxable earned surplus.

Q: Did the subsidiary's Texas franchise business loss carry over on the liquidation?
A: No. Rule 3.555(g)(3) prohibits transferring a business loss to another entity, including by merger.

Q: Does IRC Section 381 succession change the Texas result?
A: No. Federal attribute succession does not override the Texas exclusion of NOLs from earned surplus or the no-transfer rule for business losses.

Citations and references

Statutes and rules:

• Texas Tax Code Sec. 171.110(d) - excludes federal net operating losses from reportable federal taxable income
• Texas Tax Code Sec. 171.110(a) - reportable federal taxable income is the starting point for net taxable earned surplus
• Texas Tax Code Sec. 171.110(e) - defines a franchise-tax business loss and its carryforward
• Franchise Tax Rule 3.555(g)(3), 34 Tex. Admin. Code - a business loss may not be conveyed, assigned, or transferred, including by merger

Federal law referenced:

• IRC Sections 332 and 337 (non-recognition on complete liquidation) and Section 381 (succession to tax attributes)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200203958L

Original ruling text

March 29, 2002

To: **

In your facsimile of March 26, 2002, you describe a business restructuring,
which we restate as follows. A Texas corporation (P) bought all the common
stock of another Texas corporation (S), the latter having unused federal net
operating losses (NOLs). P and S are subject to the provisions of Subchapter C
of the Internal Revenue Code (IRC). In complete liquidation, S transfers all
its assets to P, which qualifies for non-recognition of gain or loss pursuant
to IRC Sections 332 and 337. Under IRC Section 381, P succeeds to the federal
tax attributes of S, including S's NOLs.

You ask if the NOLs also carryover to P for franchise tax.

The state statute and rule mentioned below, as well as other related
information, are available online at
http://www.window.state.tx.us/taxinfo/frantax.html.

Texas Tax Code (TTC) Section 171.110(d) excludes federal net operating losses
from the computation of reportable federal taxable income, the starting point
in computing net taxable earned surplus. See TTC Section 171.110(a). TTC
Section 171.110(e) does provide for the determination of a business loss for
franchise tax and the carry forward of such a loss.

Franchise Tax Rule 3.555(g)(3), however, provides: "A corporation may not
convey, assign, or transfer a business loss to another entity including, but
not limited to, by merger." Consequently, any business loss of S does not
carryover to P.

If you have other questions, please call me toll free at 1-800-531-5441,
extension 3-4931, or directly at 512-463-4931.

Bill York
[email protected]
Texas State Comptroller