Detailed Maine Development
The Maine Supreme Court recently addressed whether a hypothetical federal net operating loss could be carried forward as a deduction against state corporate income tax liability. The taxpayer, a federal affiliated group, was a member of a unitary group that generated income both within and outside of Maine. Certain members of the unitary group generated nonunitary income in the relevant tax year that was derived entirely from business activities outside of Maine. On its 2012 federal return, the group was able to use its unitary loss for that year to largely offset its nonunitary income, resulting in a federal taxable income of approximately $18 million. Under Maine law, federal taxable income is the starting point in calculating Maine corporate income tax liability. Nonunitary income generated from activities having nothing to do with Maine must be subtracted from federal taxable income. This subtraction resulted in negative federal taxable income, and therefore the taxpayer did not have any Maine corporate income tax liability for 2012. On an amended return, the taxpayer sought carry the unitary loss from 2012 forward as a deduction or subtraction to offset its federal taxable income for 2013. The Department disallowed the taxpayer’s refund and the matter was eventually litigated.
Before the court, the taxpayer argued that for federal income tax purposes, if it had not received income outside of the unitary business in 2012, it would have had a loss that could have been applied to offset 2013 taxable income. The taxpayer argued that disallowance of this hypothetical net operating loss deduction resulted in an unconstitutional indirect tax on its nonunitary income that was not allowed under an earlier Maine case (Fairchild Semiconductor Corp.). In that case, the court held that a unitary business group was entitled to a net operating loss carryback that was computed based on income earned exclusively from the group’s unitary business. After distinguishing Fairchild on the basis that the taxpayer at issue did not seek to “manipulate” income or losses in a manner that changed their treatment under the Internal Revenue Code, the court held that the taxpayer was seeking to create a new Maine deduction that was not authorized by statute and was not required under the Constitution. Under Maine law for the relevant years, there was no mechanism to carry forward a unitary loss that was not taken for federal tax purposes (due to non-unitary income). The “loss” for which the taxpayer sought recognition, the court observed, was already accounted for in determining its 2012 federal taxable income amount which, by law, is the starting point of Maine income tax calculations. The court went on to explain that, under the Constitution, states are required to fairly apportion income for tax purposes, but that no particular method of doing so is constitutionally prescribed and statutes that make reasonable efforts to properly allocate between taxable and tax-exempt income are to be upheld even if they increase an entity’s tax liability. Furthermore, the court noted that deductions are a matter of legislative grace, not a right. The court affirmed the denial of the refund. For more information on Somerset Telephone Co. please contact Nick Sequeira.
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