Do a Texas corporation's franchise-tax business loss carryovers survive converting to a Texas LLC, and then converting that LLC to an out-of-state (Nevada) LLC?

Plain-English summary

A tax adviser described a two-step reorganization for a client and asked whether Texas business loss carryovers would survive it:

1. Convert a Texas C corporation (which has Texas business loss carryovers from prior years) into a Texas LLC; then
2. Convert that Texas LLC into a Nevada LLC on or before December 31, 2002.

The Comptroller answered yes at each step:

• Step 1 (corporation to Texas LLC). The Texas business loss carryover of the pre-conversion Texas corporation remains available for use on the future franchise tax reports of the post-conversion Texas LLC. This is consistent with the Comptroller's earlier letter ruling 9910776L.
• Step 2 (Texas LLC to Nevada LLC). The business losses continue to be available to the Nevada LLC after the second conversion.
• The carryforward rule. Tax Code Sec. 171.110(e) defines a business loss as "any negative amount after apportionment and allocation," and provides that it is carried forward to the year after the loss year as a deduction to net taxable earned surplus, then successively for up to five taxable years after the loss year, or until the loss is exhausted, whichever comes first.
• Caveat. The Comptroller noted the response is based on current law and the facts presented; different or additional facts could change it.

Currency note: This letter describes the pre-2008 franchise tax and its earned-surplus business loss carryforward. House Bills 3 and 3928 replaced that tax with the current margin tax effective January 1, 2008, which has its own (different) treatment of business losses. Treat this letter as historical.

What this means for you

Businesses reorganizing entity form (pre-2008 context)

Under the old franchise tax, a straight conversion of a Texas corporation to an LLC - and even a follow-on conversion to an out-of-state LLC - did not, by itself, wipe out accumulated Texas business loss carryovers; the losses followed the converting entity, subject to the five-year limit in Sec. 171.110(e).

Advisers modeling loss usage

Track the loss year: the carryforward runs to the next year and then for up to five taxable years after the loss year, or until exhausted. Conversions in this fact pattern preserved the losses but did not reset that clock.

Common questions

Q: Did converting a Texas corporation to a Texas LLC destroy its franchise-tax loss carryovers?
A: No. The losses stayed available on the Texas LLC's future franchise tax reports.

Q: What about the second conversion, to a Nevada LLC?
A: The Comptroller said yes - the losses remained available after that conversion too.

Q: How long could a business loss be carried forward?
A: Under Sec. 171.110(e), to the year after the loss year and then successively for up to five taxable years after the loss year, or until the loss is exhausted, whichever occurs first.

Citations and references

Statutes:

• Texas Tax Code Sec. 171.110(e) - defines a business loss as any negative amount after apportionment and allocation, carried forward as a deduction to net taxable earned surplus for up to five taxable years after the loss year

Related letter ruling:

• 9910776L - Texas business loss carryover survives a corporation-to-LLC conversion

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200206204L

Original ruling text

June 21, 2002

Dear Mr. *****:

Thank you for your letter regarding business loss carryovers for franchise tax
reporting.

You stated in your letter that your client is a Texas corporation ("Texas C
Corp"), which has Texas business loss carryovers from prior years. It plans to
(1) convert to a Texas limited liability company ("Texas LLC"), and then (2)
convert Texas LLC to a Nevada limited liability company ("Nevada LLC") on or
before December 31, 2002.

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

Question 1: Based on letter ruling 9910776L, it appears that the Texas
business loss carryovers of Texas C Corp will carryover and be available for
use by Texas LLC after the first conversion. Is this still correct?

Response: Yes, the Texas business loss carryover of the pre-conversion Texas
Corporation will be available for use on the future Texas franchise tax reports
of the post-conversion Texas Limited Liability Company.

Section 171.110(e) defines a business loss as "any negative amount after
apportionment and allocation." This section also states that "the business
loss shall be carried forward to the year succeeding the loss year as a
deduction to net taxable earned surplus, then successively to the succeeding
four taxable years after the loss year or until the loss is exhausted,
whichever occurs first, but for not more than five taxable years after the loss
year."

Question 2: Assuming that question #1 is answered in the affirmative, will the
business losses of Texas LLC (from Texas C Corp) carryover and be available for
use by Nevada LLC after the second conversion?

Response: Yes.

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 any questions about this or any other franchise tax matter, please
call me at 1-800-531-5441, extension 34612. My direct number is (512)
463-4612. You may write me at Tax Policy Division, Comptroller of Public
Accounts, Austin, Texas 78774 or via email to .

Sincerely,

Janet Spies
Tax Policy Division