Arkansas: Taxpayer Required to Addback Section 965 Income in Computing NOL

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 IRC section 965 income was included in the calculation of gross income for purposes of determining an Arkansas net operating loss (NOL). 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.  As a result of the mandatory repatriation provisions in the Tax Cuts and Jobs Act, the taxpayer had a deemed inclusion of IRC section 965 income on its 2017 federal income tax return. Arkansas did not, and does not, conform to IRC section 965. Accordingly, in computing its NOL, the taxpayer did not treat the IRC section 965 as nontaxable income (i.e., the taxpayer did not add the deemed income back to gross income in computing the Arkansas NOL). On audit, the Department adjusted the 2017 return by adding back the IRC section 965 income, which eliminated the NOL. The taxpayer timely protested.

Although not as clearly stated in the decision, the crux of the matter before the ALJ was whether income resulting from a provision of federal law that Arkansas does not adopt (IRC section 965) is treated as nontaxable income in computing the state NOL carryover. The ALJ observed that in two previous Arkansas Supreme Court cases, St. Louis Southwestern Railway and Kansas City So. Ry. Co., 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.  After reviewing the holdings in the cases, the ALJ concluded that the Department position was consistent with controlling authority and that the taxpayer had presented no authority to rebut the Department’s arguments. The ALJ did not address the conformity issue and whether income that was not taxable in Arkansas because the state did not conform to the underlying provision was properly treated as nontaxable income for purposes of computing gross income. The ALJ next upheld the failure to file penalty. For more information on Docket No.:21-461 please contact Jennifer Knickel

This Week's Developments

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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US