South Carolina addresses the application of section 382
Provides guidance on the use and calculation of the NOL limitation
TAX ALERT |
On July 6, 2016, the South Carolina Department of Revenue issued Revenue Ruling #16-7, providing a discussion of South Carolina net operating losses (NOL), the application of section 382 and other limitations on South Carolina consolidated returns.
South Carolina adopts section 172 (addressing the NOL deduction), with the exception of subsection (b)(1) relating to NOL carrybacks, for the purpose of calculating NOLs. The state also adopts the 20-year carryforward period. Accordingly, the South Carolina NOL deduction is calculated based on the Internal Revenue Code subject to certain modifications.
South Carolina section 382 limitations on NOL carryforward
The ruling begins with a brief summary of the section 382 limitation for federal purposes before discussing the limitation for state purposes. South Carolina has adopted section 382, but the limitation calculation depends on the extent of the in-state business activity of the loss corporation. Accordingly, the federal and state limitation amounts will generally be the same if the loss entity conducts its entire business within South Carolina during the taxable year that the change occurs. However, if the loss corporation has apportioned its South Carolina income in the taxable year that the ownership change occurs, the section 382 limitation will be calculated by apportioning the federal section 382 limitation using the South Carolina apportionment ratio for the taxable year that the ownership change occurs. The South Carolina NOL remains subject to the 20-year carryforward period. The ruling provides the following example to illustrate:
Assuming the following for Company A at time of ownership change:
- Company A’s value is $5 million
- The applicable federal long-term tax exempt rate is 2.8 percent
- Company A’s federal NOL carryforward is $1 million
- Company A’s previously apportioned South Carolina NOL carryforward is $350,000
- Company A’s South Carolina apportionment ratio for the year of the ownership change is 25 percent
Company A’s federal section 382 limitation is $140,000, or $5 million of value multiplied by the long-term exempt rate of 2.8 percent. The South Carolina limitation is $35,000, or $5 million multiplied by 2.8 percent multiplied by 25 percent. Therefore, the taxpayer can offset up to $35,000 of its South Carolina taxable income in each year following the ownership change.
Built-in gains and losses
The ruling next explains the state treatment of net unrealized built-in gains (NUBIG) or net unrealized built-in losses (NUBIL) as required by section 382(h). For South Carolina income tax purposes, a loss corporation’s state NUBIG or NUBIL must meet the threshold requirement to qualify for the section 382 limitation adjustment, which depends on whether the loss corporation met the federal threshold, i.e., 15 percent of the fair market value of the loss corporation’s assets on the date of change or $10 million.
For purposes of the NUBIG, if a loss corporation meets that threshold on a separate company basis for federal purposes, then the loss corporation is deemed to have met the South Carolina threshold requirement. There are two methods to calculate the South Carolina NUBIG in that scenario:
- A simplified method that multiplies the federal NUBIG amount calculated on a separate company basis by the South Carolina apportionment ratio for the year the change occurs
- A detailed method using the state’s income tax modifications and allocation and apportionment provisions
If a loss corporation does not meet the federal NUBIG threshold, the corporation may still meet the state NUBIG threshold requirement if the loss corporation’s detailed state NUBIG exceeds 15 percent of the fair market value of the loss corporation’s assets on the date of change or $10 million.
Similarly, for purposes of the NUBIL, the analysis for determining the loss corporation’s South Carolina NUBIL and NUBIL threshold depends on whether the loss corporation has met the federal NUBIL threshold. If the loss corporation’s federal NUBIL does not exceed the federal statutory threshold, then none of the loss corporation’s South Carolina recognized built-in loss is subject to the state section 382 limitation and the loss corporation will not need to calculate its detailed state NUBIL or NUBIL threshold.
South Carolina consolidated returns
Finally, the ruling discusses the South Carolina consolidated (combined) returns. South Carolina permits the use of the consolidated return when entities doing business in the state share at least 80 percent ownership of the total combined voting power of all classes of stock. However, the state has not adopted the federal consolidation rules in sections 1501 through 1505 and in the related regulations. For South Carolina purposes, state taxable income is calculated separately for each entity, thus income is allocated and apportioned separately for each corporation. The separately computed state income or loss of each member of the group is added together to calculate the South Carolina income or loss for the consolidated group.
Because the South Carolina consolidated return is not like the federal consolidated return, the South Carolina section 382 limitation is computed separately for each group member. Each member must compute the separate value at the time of the ownership change and then apportion the value using the state apportionment ratio for that member in the year of change. Built-in gains and losses must be calculated separately for each member under the procedures outlined above.
Additionally, South Carolina has not adopted the federal separate return limitation year rules and, as the ruling suggests, there are other rules in place to prevent abuse of the NOL rules.
The ruling provides a comprehensive overview of South Carolina’s approach to section 382 for state purposes. The ruling includes a number of calculation examples as well as detailed analysis of the necessary procedures to determine built-in gains and losses. Taxpayers maintaining South Carolina NOLs potentially impacted by section 382 should review the ruling and discuss with their tax advisor how the ruling may impact South Carolina NOL utilization.