Potential NOL Carryback Limitations
for NYC Partnerships and LLCs
Under the CARES Act, a net operating loss (NOL) generated in 2020 can be carried back as much as five years which will allow taxpayers to receive tax refunds based on the net operating loss generated in 2020. The federal laws regarding the utilization of NOLs are straightforward. The states’ laws are fairly simple, too, as they are generally limited to the federal NOL utilization and, in some cases, are also capped at a specific amount, depending on the jurisdiction. Some states also vary as to whether state modifications should be taken into account when calculating the NOL utilization.
When it comes to New York City partnerships and LLCs, however, the rules are fairly complex for NOL utilization against the New York City Unincorporated Business Tax (“NYC UBT Tax”). And may result in NYC partnerships and LLC not being able to have the benefit of an NOL carryback.
The New York City Administrative Code Section 11-507(b) states: “In the case of a partnership, no NOL carryback or carryover to any taxable year shall be allowed unless one or more of the partners during such taxable year were persons having a proportionate share of interest or interests, amounting to at least 80% of all such interests, in the unincorporated business gross income and unincorporated business deductions of the partnership that sustained the loss for which a carryback or carryover is claimed.”
The key factor when determining the NOL utilization allowed in a given year for New York City partnerships is to look at the partnership ownership percentages by partner, both in the original loss year when the NOL was first generated, as well as in the current year where there is income and one wants to utilize the NOL.
There are two main steps for computing the NOL utilization allowed in a given year, which must be done separately for each NOL from a tax year. There are often errors made on this form where the accountant does not utilize any NOL at all, even though they were entitled to some or all of it, simply because they didn’t enter the two key percentages as described in detail below.
Step 1 – Loss-Year Percentage
Compute and enter the total percentage interests in income and deductions for the loss-year partners who were also partners during the current year. This represents the partner’s ownership percentages in the loss year for only the partners who are still currently in the partnership. For instance, if a partner was present in the loss year and is no longer currently in the partnership, this percentage will be less than 100%. If this percentage is equal to or greater than 80%, then you proceed to step 2. If it less than 80%, you may not continue and you are not allowed to utilize any NOL carryforward. The NOL is lost forever.
It is similar to that of corporations with respect to Section 382 limitations, where taxpayers are prevented from “buying” NOLs. If a new partner enters a partnership after the loss year, it can cause the NOL loss to be limited or lost altogether.
Step 2 – Current-Year Percentage
Compute and enter the total percentage interests in income and deductions for the current year for those who were partners in both the loss year and in the current year. For the partners identified in step 1 above, this represents their current-year partnership ownership percentages. Whatever that percentage is, you are limited to utilizing this percentage of the NOL and the remaining balance is lost forever. Also, the NOL utilization cannot exceed New York City taxable income. Let’s examine some hypothetical examples.
In 2015, John and David each owned 50% of ABC Partnership. The 2015 NOL was $1,000,000. In 2016, there was an additional NOL of $500,000, and John and David each owned 50% of ABC Partnership in that year as well. John and David each owned 50% of the partnership in 2017, and there was income of $1,500,000. Since the loss-year percentage is 100% for both 2015 and 2016 NOLs, proceed to step 2 and the current year percentage is also 100%. ABC Partnership can utilize 100% of the NOL carryover to 2017 to the extent it reduces taxable income to zero. In other words, they can utilize the full $1,500,000 of the NOL carryforward from the prior years.
Assume the same facts in the above example, except that on January 1, 2017, John sold 20% of his 50% partnership interest (10% of the total partnership) to a new partner, Brett. Therefore, in 2017 John is allocated 40% of the partnership’s profits, while 50% is allocated to David and 10% is allocated to Brett. The loss-year percentage for the 2015 and 2016 NOLs is still 100%, as John and David are still in the partnership. Therefore, proceed to step 2 and the current year percentage is 90%.
ABC Partnership is entitled to utilize 90% of its 2015 NOL, or $900,000. It also can utilize up to 90% of its 2016 NOL, or $450,000. Therefore, ABC Partnership is entitled to utilize $1,350,000 of its prior year NOL carryforwards to offset against the current-year income of $1,500,000, leaving net income of $150,000. The remaining $150,000 of NOL carryforwards from the prior years is lost forever.
Assume the same facts in example B above, except that on January 1, 2017, John sold his entire 50% interest to a new partner, Brett. Therefore, in 2017 John is allocated 0% of the partnership profits, while 50% is allocated to David, and 50% is allocated to Brett.
The loss-year percentage is only 50%, since John is no longer being allocated any profits in 2017, and you cannot even proceed to step 2. No NOL utilization is allowed and the prior year NOL carryforwards of $1,500,000 are lost forever.
Proper planning should be done to maximize the NOL utilization allowed in a given year, as well as allow a taxpayer to plan appropriately for quarterly estimated tax payments. As such, it is critical to understand the mechanics of the New York City partnership NOL utilization rules.
The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.