Originally published on Forbes.com Aug 12th, 2014
2008 seems to have been a tough year for private equity investor, Stephen Adams and his wife Denise. According to a decision on the Connecticut Superior Court, their 2008 federal individual income tax return showed a net operating loss of $66,044,546. Mr. Adams apparently is involved among other things in outdoor advertising and television and radio. My attempts to correlate that impressive individual NOL, which I would think must come from flow-throughs to some publicly know event have gone nowhere. I suspect there is an interesting story there, but not one that a mere tax blogger can penetrate.
The silver lining in the cloud of massive losses was that in 2008 a net operating loss could be carried back five years. The Adams had significant federal taxable income in the years 2003 – 2006 – $2,874,720, $13,692,032, $29,960,043 and $10,848,903. Unlike its neighbor Massachusetts, which only wants to be your partner when you are making money, Connecticut will refund taxes based on net operating loss carrybacks. The litigation was about how precisely that carryback should work. As you might guess, the Adams were arguing for a larger refund.
High as their income was for federal income tax purposes in all those years, their Connecticut income was much higher. Nearly $10 million higher in 2003, over $20 million higher in 2004 and 2005, and over $15 million higher in 2006. It’s pretty easy to make an educated guess as to why there is such a difference. It is well known that Stephen and Denise Adams are very charitable people. According to this story, the originally mysterious gift of $100 million to the Yale School of Music in 2005 was actually from their family foundation. (Note: That cannot be what created the net operating loss. Charitable deductions are limited based on adjusted gross income.) Connecticut would not have allowed the charitable deductions.
So taking 2003 for starters the federal net operating loss allowed was $2,874,720. The taxpayer’s argument is that is fine for federal purposes, but for Connecticut purposes, the limit should be based on Connecticut income which was $12,429,994. The interesting thing is that following that same logic in each of the subsequent years, that is taking the federal deduction and adjusting the limit for the higher Connecticut income in that year, they take in total a federal net operating loss of $66,044,546 or which $57,375,698 was allowed as a carryback and deduct $116,584,867 on the Connecticut carryback claims. Not quite multiplying loaves and fishes, but still pretty slick. The Court indicated that this was something of a bizarre result, which is a sign of how the decision is going to turn out well for the taxpayers.
The decision was a more or less “It is what it is. Deal with it.” type of ruling.
In order to agree with the plaintiffs’ concept of treating NOLs deducted from federal AGI rather than federal taxable income, the legislature would have to address this issue by enacting legislation permitting a Connecticut individual income taxpayer the right to offset federal NOLs against CAGI, not federal taxable income.
Presumably, if they did do that sort of legislation there would be some sort of separate NOL tracked to avoid double-dipping.
Recognizing that Connecticut individual state income taxes are a creature of statute, see § 12-700 et seq., the lack of statutory authority to deduct NOLs arrived at under federal tax laws, precludes the plaintiffs from deducting NOLs from CAGI rather than federal taxable income. NOLs were created under federal tax laws to deal with excess business losses used to offset positive income years arrived at under federal tax laws. Federal tax laws provide for the limitation on the use of NOLs to taxable income rather than AGI. This is more in line with the application of federal tax concepts to Connecticut tax laws. Considering all of the factors in this case, the only conclusion for the court to arrive at is that the plaintiffs are limited to applying their federal NOLs to federal taxable income rather than to CAGI, which is, in fact, federal AGI.
I think the moral of the story might be that if you think federal taxes are really, really hard to figure out, you haven’t looked at state taxes all that much.