Application of a 382 Limitation for California Tax Purposes

As you may know, IRC section 382(b) provides pre-ownership change tax attribute usage limitation when a corporation experiences of an ownership change as defined under IRC section 382(g).  It wasn’t clear until now whether the limitation is applied on a pre-apportionment basis or a post-apportionment basis for California tax purposes.  California issued Technical Advice Memorandum 2017-03 (“TAM 2017-03”) clarifying how the limitation should be applied.

According to the TAM 2017-03, the 382(b) limitation is applied on a pre-apportionment basis.  However, annual limitation adjustment due to RBIGS and RBILS (recognized built-in gains / recognized built-in loss) under IRC section 382(h) would be determined on a post-apportionment basis. (I will omit the discussion of RBIGS and RBILS).

Note that many states have differing interpretations and applies the limitation on a post-apportionment basis.

 

Here is an illustration:

The Company X has $10,000,000 net operating loss and experienced a 382 ownership change.  Say the annual limitation is determined to be $300,000.   The Company X has pre-apportioned California taxable income of $1,000,000.  Say the California apportionment percentage is 15%.  Based on TAM 2017-03, the Company X’s California taxable income is computed as follow:

 

Pre-apportioned taxable income	$        1,000,000
382 NOL limitation	(300,000)
	$            700,000
Apportionment %	15%
California taxable income	$            105,000

 

Prior to the issuance of the TAM, many tax practitioners applied the annual limitation on a post-apportionment basis which results in a very different outcome, as illustrated below:

 

Pre-apportioned taxable income	$        1,000,000
Apportionment %	15%
	$            150,000
382 NOL limitation	(300,000)
California taxable income	$                None

 

Please refer to the link below for further discussion.

https://www.ftb.ca.gov/law/Technical_Advice_Memorandums/2017/03.pdf