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Net Operating Losses and State Tax Rates: Taxpayers Feel the Impact

6 Jul 2011

While it is no secret that many states are feeling the effects of a sluggish economy, the actual statistics may be somewhat surprising. As of the third quarter of 2010, state tax collections, adjusted for inflation, were approximately 11 percent below pre-recession levels. Additionally, although states were able to close large shortfalls in fiscal years 2009-2011, approximately 44 states and the District of Columbia are still projecting budget shortfalls for fiscal year 2012 totalling roughly $112 billion. Further, 26 states have already projected budget shortfalls for fiscal year 2013 totalling $75 billion. Based on this, it is clear that states must take action, and quickly, to close these budget gaps. Taxand US discusses two ways in which states are attempting to "get tough" (even if it is at the taxpayer's expense) to reduce or eliminate budget gaps:

1. by suspending or limiting net operating loss (NOL) deductions
2. by increasing state tax rates.

For a review of individual state measures, and to read more information on Net Operating Loss Deductions, please click here.

Taxand's Take

As states attempt to "get tough" to close budget gaps, taxpayers will need to stay aware of state tax law changes, particularly NOL deduction rule changes and increased corporate tax rates. These changes can have a significant impact on the state tax provision and on the amount of work created in the tax department.

Taxpayers must keep in mind that both NOL and rate changes must be accounted for in the period that includes the enactment date of the tax law change. Among other items, taxpayers will need to evaluate whether it is more likely than not that NOLs will be utilised after a tax law change and must determine the impact that this has on the valuation allowance. Further, consideration will need to be given to items such as whether rate changes will impact a taxpayer's deferred tax assets and liabilities. As you can see, tax departments can quickly find themselves overwhelmed.

Finally, time will certainly tell whether states that have become more aggressive by offering incentives in an attempt to raise the tax base, and thus pulling businesses into their jurisdictions, will prevail over those that seem to believe the only option is to further tax businesses operating in the state. Out of the gates there is certainly more activity by businesses giving consideration to relocation based on tax incentives than we have seen in a long time.

Your Taxand contact for further is:
John Easterday
T. +1 312 288 4015

Taxand's Take Author