Could a corporation deduct a federal net operating loss in Texas earned surplus, and how did the separate Texas business-loss carryforward work?

Plain-English summary

Federal net operating losses did not reduce earned surplus; Texas used a separate apportioned business-loss carryforward.

Section 171.110(d) began with federal taxable income before net operating loss deductions, so a federal NOL could not be deducted.

Sections 171.110(a)(4) and (e) instead allowed a Texas business loss, defined as a negative amount after apportionment. The loss carried forward for five years or until exhausted, whichever came first, subject to two limits:

• a tax-year loss ending before January 1, 1991 could not be used; and
• the deduction could not reduce earned surplus below zero.

Currency note: This is a pre-2008 earned-surplus loss rule. Texas replaced the former tax with the margin tax effective January 1, 2008.

What this means for you

Corporations with federal and Texas losses

The two losses were not interchangeable. Track the post-apportionment Texas amount and its own five-year life.

Tax professionals

Do not import federal NOL carryback or carryforward treatment into the former earned-surplus base.

Common questions

Q: Could a federal NOL reduce earned surplus?
A: No.

Q: How long did a Texas business loss last?
A: Five years or until exhausted.

Q: Could it create negative earned surplus?
A: No.

Citations and references

• Texas Tax Code Secs. 171.110(d), 171.110(a)(4), and 171.110(e)
• 34 Tex. Admin. Code Sec. 3.544(c)-(d)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9808721L

Original ruling text

August 13, 1998

Dear Ms. **:

Thank you for your letter regarding the proposed amendments to franchise tax
rule 3.544 and the carryback of federal net operating losses.

I have enclosed a copy of proposed rule 3.544 for your review. Subsections
(d)(2), (d)(3) and (d)(4) contain new language relating to franchise tax
amendments as a result of a Revenue Agents Report (RAR) or an amended federal
income tax report. Subsection (c) discusses the procedure for amending a
franchise tax report.

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.

However, TTC Section 171.110(a)(4) provides for the deduction of a business
loss, which is defined in TTC Section 171.110(e) as "any negative amount after
apportionment." 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. This section of the TTC also states that "a business loss from a tax
year that ends before January 1, 1991, may not be used to reduce net taxable
earned surplus." A business loss that is carried forward to a successive year
may not reduce the amount of earned surplus below zero.

This response is based on the facts presented and current law.

If you have any questions about this or any other franchise tax matters, please
write me or call me at 1-800-531-5441, extension 34612. My regular number is
(512)463-4612.

Sincerely,

Janet Spies
Tax Policy Division