Maryland addresses acquired entity NOL treatment


Jamie C. Yesnowitz 
Washington, DC
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Matt Libeg
Metro DC - Arlington
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Chuck Jones 
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Lori Stolly 
T +1 513 345 4540 

Patrick Skeehan
T +1 215 814 1743  

A recent Maryland Tax Court decision provides businesses with a potential opportunity to reconsider how they have treated net operating loss (NOL) attributes obtained from acquired entities for purposes of the Maryland corporation income tax.1 The Tax Court held in favor of a taxpayer that challenged a regulation adopted by the Maryland Comptroller restricting the use of NOLs that had been incurred by two entities that it acquired through merger.

Background The taxpayer, an equipment and tool rental company, began filing Maryland corporation income tax returns in 2005. At the end of 2006, the taxpayer acquired two entities doing business outside Maryland that had incurred NOLs from 2003 to 2006. The two acquired entities did not file Maryland corporation income tax returns before the merger. The taxpayer deducted NOLs from 2007 to 2013, which included NOLs from the merged entities. The Comptroller allowed the taxpayer’s NOL deductions from 2007 to 2010, but denied these deductions for the 2011, 2012, and 2013 tax years to the extent such deductions were based on carryforwards of the merged entities’ NOL amounts. The Comptroller issued a notice of final determination, assessing the taxpayer an undisclosed amount of tax, and both the Comptroller and taxpayer filed motions to be addressed by the Tax Court.

Maryland treatment of NOLs As a “line 30” state, the Maryland tax code generally follows the federal NOL regime under IRC Sec. 172, with the ability for a corporate income taxpayer to make limited state-specific addition and subtraction modifications to the federal NOL.2 The Comptroller adopted the following change to its regulation governing the state NOL calculation in late 2007:

If a liquidated or acquired corporation was not subject to Maryland income tax law when its net operating loss was generated, then the acquiring corporation which is subject to Maryland income tax law may not use the net operating loss of the liquidated or acquired corporation as a deduction to offset Maryland income.3

In addition, the Comptroller issued an administrative release that it has updated several times that endorses the revised policy in the regulation. In the release, the Comptroller included two separate examples of Maryland companies liquidating or acquiring other out-of-state companies with NOLs, holding that the Maryland companies could not use these NOLs to offset Maryland income.4

Tax Court’s brief consideration of arguments The taxpayer argued that the Comptroller’s denial of the merged entities’ NOLs was improper because the amended regulation: (i) was contrary to Maryland statute; (ii) could not apply to NOLs generated and acquired before the regulation’s 2007 effective date; and (iii) discriminated against interstate commerce as a Commerce Clause violation.

In response, the Comptroller argued that the adopted regulation was reasonable, disagreeing with the taxpayer’s view that Maryland modified income is equal to the federal taxable income of each corporation (which would require inclusion of the merged entities’ NOL carryforwards in the taxpayer’s NOL deduction).5 Rather, the Comptroller took the position that the entire statutory scheme governing the Maryland corporation income tax should be considered in interpreting the regulation. By doing so, the Comptroller argued that the term “taxable year,” defined in the Maryland tax code as “the period for which Maryland taxable income is computed ...”6 was relevant, because the merged entities had no taxable year. Since that was the case, the Comptroller opined that the NOLs of the merged entities likewise did not have nexus with Maryland and could not be part of the taxpayer’s NOL deduction.

The Tax Court rejected the Comptroller’s argument, summarily holding that Maryland’s conformity to the federal income tax regime meant that only modifications to federal taxable income permitted by statute can be made. As the Comptroller’s action served to make a modification to federal taxable income via regulation, such action was invalid. Based on this conclusion, the Tax Court did not address the taxpayer’s other arguments.

Commentary The taxpayer’s fact pattern in this case is relatively common, under which a company that acquires a target wants to utilize the NOLs of the target following an acquisition. Often, the potential availability of this tax attribute may be an important driver of the deal itself. For federal income tax purposes, limitations on using the NOL are often applied, and determining whether such limits are applicable often requires a complicated analysis. From the state income tax perspective, this issue becomes even trickier when the target historically has not been taxable in the state in which the acquirer is filing a return. Many states do not speak to the availability of the state NOL in that instance, and several of those that do take the position that is espoused in the Comptroller’s regulation at issue deny the use of the NOL.

The Tax Court only needed a little more than three pages to determine that the Comptroller’s regulatory authority is not absolute, and that it cannot create modifications to federal taxable income that go beyond statutory modifications that are already in place. To the extent corporate taxpayers that have been active on the acquisition front have followed the Comptroller’s regulation and associated administrative guidance regarding acquired NOLs, potential protective claims for refund for open tax periods should be considered.

While this case specifically addresses NOLs acquired from another taxpayer via merger or liquidation, the Tax Court’s broad ruling has potentially greater implications and also may apply to NOLs generated by the taxpayer itself. In 2007, at the same time that the regulatory language addressed in this case was promulgated, the Comptroller also added language providing that “[a] net operating loss generated when a corporation is not subject to Maryland income tax law may not be allowed as a deduction to offset Maryland income.”7 Under the rationale that the changes to the Comptroller’s regulation were not supported by statute, this case calls into question whether this ancillary NOL provision is invalid as well. Accordingly, taxpayers claiming their own NOLs that were limited by the Maryland regulation also should consider filing protective refund claims.

Taxpayers also should consider this case in light of the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc.8 and the continued trend toward economic nexus policies being imposed on income taxes. Under this approach, taxpayers potentially could strengthen the argument that they should be able to use their NOLs from years during which they may not have had traditional physical presence nexus, by arguing that they had economic nexus in Maryland by virtue of certain activities in the state.

It would not be surprising if the Comptroller appeals this decision, which may put in doubt some of the Comptroller’s current regulations that may go beyond the dictates of the Maryland tax statutes, and may substantially limit the ability of the Comptroller to issue interpretive regulations in the future. If the decision is appealed and moves through the Maryland courts, it is possible that the retroactivity and constitutional arguments not addressed by the Tax Court will receive more extensive consideration.


1 Sunbelt Rentals v. Comptroller of Maryland, Maryland Tax Court, Case No. 18-IN-00-0241, Sep. 9, 2019.
2 MD. CODE ANN., TAX-GEN § 10-304(1); MD. REGS. CODE tit. 03, §
3 MD. REGS. CODE tit. 03, §
4 Administrative Release No. 18, Maryland Comptroller of the Treasury, July 1, 2013, § II.B.1.
5 Pursuant to MD. CODE ANN., TAX-GEN § 10-304.
6 MD. CODE ANN., TAX-GEN § 10-101(o)(1)(i).
7 MD. REGS. CODE tit. 03, §
8 138 S. Ct. 2080 (2018). For a discussion of this case, see GT SALT Alert: Wayfair Ruling Overturns Quill Physical Presence Requirement.

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