Arkansas: Nontaxable Income Required to be Included in NOL Computation

Listen to a brief overview of state tax developments this week, including Arkansas, or read full Arkansas development below.

Detailed Arkansas Development

An Administrative Law Judge (ALJ) for the Arkansas Department of Finance and Administration Office of Hearings and Appeals recently addressed whether nontaxable partnership income was included in the calculation of an Arkansas net operating loss (NOL). The taxpayer, a corporation, owned an interest in a partnership that had income sourced to Arkansas. On audit, it was revealed that the taxpayer’s tax computation included a claimed Arkansas NOL carryforward, but in the taxpayer’s calculation of that NOL, the taxpayer did not add back certain non-taxable income related to the taxpayer’s partnership interest. After recalculating the taxpayer’s NOL, the Department determined there was an outstanding tax liability and issued an assessment. The taxpayer timely protested.

Under Arkansas law, taxpayers are allowed an NOL carryforward deduction equal to the excess of allowable deductions over the gross income for the taxable year. In computing the NOL, taxpayers are required to add back all nontaxable income not required by law to be reported as gross income. Corporations with partnership income generated from activities within and without the state are required to directly allocate the partnership income from activities within Arkansas. Therefore, partnership income not directly allocated to Arkansas is excluded from Arkansas gross income and is not subject to taxation.

The ALJ determined, based on two previous Arkansas Supreme Court cases, that the partnership income not allocated to Arkansas was considered “nontaxable income” for purposes of calculating the Arkansas NOL, regardless of whether the income was taxed by another jurisdiction.  Citing to St. Louis Southwestern Railway and Kansas City So. Ry. Co., the ALJ outlined how the court had previously required nonbusiness income allocated to other states, as well as dividend income specifically excluded from gross income, to be added back in computing the Arkansas NOL.  The taxpayer argued that including the income not allocated to Arkansas amounted to double taxation. However, the Administrative Law Judge reasoned that because the income was not taxed within Arkansas and was in fact allocated to other states, it was considered nontaxable income for Arkansas purposes. Furthermore, the ALJ noted that although the double taxation argument presented by the taxpayer was not persuasive, the Office of Hearings and Appeals did not have jurisdiction or authority to overturn a statute based on constitutionality.  Therefore, the ALJ held that the partnership income allocated to other states was required to be included in the NOL calculation and affirmed the assessment. For more information on Docket No.:21-313 (2015) please contact Jennifer Knickel

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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US