Opinion handed down June 11,
2013.
In
2005, Jonathan D. Eilian incurred a substantial net operating loss recognized
under federal tax law. On his Missouri tax returns, Mr. Eilian used the
negative amount owing to this net operating loss as the starting point for his
state taxes. Therefore, Mr. Eilian’s income that was taxable under Missouri,
but not federal law, was entirely subsumed in his federal net operating loss.[2] Applying Brown Group, Inc. v.
Administrative Hearing Commission as the rule of decision, the Supreme
Court of Missouri held that Mr. Eilian used his federal net operating loss
improperly to offset his Missouri taxable income and remanded the case for a
final calculation of the taxpayer’s Missouri tax liability.
I. Facts and
Holding
In 2005, taxpayer Jonathan D. Eilian incurred a massive net
operating loss. Under section 172 of
the Internal Revenue Code, Elian elected to carry this loss forward and use it
to offset his federal taxes in subsequent years beginning in 2006.[3] Under
Missouri Revised Statutes section 143.121.1, the starting point for an
individual’s Missouri taxes is the taxpayer’s federal adjusted gross income.[4] Because his federal taxable income for 2006 was still far less than the amount
of his net operating loss deduction for that year, Mr. Elian determined that
the starting point for his 2006 Missouri taxes under section 143.121.1 was the
difference between his federally taxable income and the full amount of his net
operating loss deduction – a negative number.[5] Thus, when Elian was required
to add certain income that is taxable only under Missouri law to this starting
point, his Missouri taxable income was completely subsumed in the federal net
operating loss.[6]
The Missouri Director of Revenue determined that Elian’s use
his federal net operating loss was improper and sent Elian a notice of
deficiency.[7] Elian challenged this determination before the Administrative
Hearing Commission, which reversed the Director and found in Elian’s favor.[8] The Director of Revenue appealed to the Supreme Court of Missouri.[9]
To determine how and to what extent federal tax benefits
like the net operating loss deduction influence state tax benefits under
Missouri law, the Supreme Court of Missouri first applied the strikingly
similar case of Brown Group, Inc. v. Administrative
Hearing Commission. In rejecting the taxpayer’s argument that the starting
point for Missouri taxes can be a negative number, the Brown court held that the reference to “income” in the Missouri
statute means “income which may be taxed.”[10] While this amount may be reduced
to zero by a federal net operating loss deduction, any amount less than zero
would not be income that could be taxed at all but would simply be a loss,
which cannot be taxed.[11] Furthermore,
the court in Brown held that, because
the net operating loss deduction is a federal statutory creation, a taxpayer
may take advantage of the benefits of that deduction only to the extent that
the deduction results in a reduction of federal taxable income.[12] Under
federal law, the net operating loss deduction may not be used to reduce taxable
income below zero, and Missouri law only authorizes Missouri tax benefits
flowing from this deduction to the extent allowed under federal law.[13] Stated
simply, neither federal nor Missouri law allows for the extra tax benefits that
would flow from allowing a negative number to be used as the starting point for
Missouri taxes. Therefore, the starting point for Missouri income taxes cannot
be less than zero, regardless of the amount of the federal net operating loss
deduction.[14]
Elian made two unsuccessful arguments against the
applicability of Brown. First, Elian
argued that Brown did not apply
because he was an individual taxpayer whereas the taxpayer in Brown was a corporation.[15] Thus, he
argued, the rule of Brown applies
only to the Missouri statute governing the starting point for corporate
taxpayers.[16] The Supreme Court of Missouri rejected this argument by noting
that the corporate and individual taxpayer statutes use the same word –
“income” – in the exact same context and there is no justification for
interpreting them differently.[17]
Second, Elian argued that subsequent legislation had
abrogated the holding in Brown.[18] Specifically,
Elian argued that section 143.431.5,[19] added after Brown was decided, now allows a federal net operating loss to be a
positive or negative number for Missouri tax purposes.[20] The Supreme Court of
Missouri disagreed, reiterating that one of the holdings of Brown was that Missouri tax benefits
attributable to a federal net operating loss are only allowed to the extent
that such benefits are available under federal law.[21] Because federal law
does not allow a net operating loss deduction to reduce income below zero, the
starting point for Missouri taxes is likewise limited.[22]
Therefore, the Supreme Court of Missouri held that the
Missouri tax benefits owing to a federal net operating loss may only be
realized by the taxpayer to the extent that such a benefit is allowed under
both federal and state law.[23] Because federal law does not authorize a
taxpayer to use a net operating loss to reduce income to an amount less than
zero, no additional Missouri tax benefits may be gained by doing so.[24] Accordingly, Eilian was entitled to reap one hundred percent of the benefit of
his federal net operating loss in calculating his Missouri taxes by beginning
the calculation of those taxes at zero.[25] He was not entitled to gain further
unauthorized Missouri tax benefits by using his federal net operating loss to
offset income taxable only under Missouri law.
II. Legal Background
A. Missouri Tax
Structure
The controversy in Eilian
arose because the starting point for determining Missouri income taxes are
“coupled” to federal adjusted gross income.[26] Under Missouri Revised Statutes
section 143.121.1, “Missouri adjusted gross income…shall be the taxpayer's
federal adjusted gross income.”[27] Once this starting point is determined, the
remainder of section 143.121 outlines certain additions and subtractions in
order to determine the taxpayer’s Missouri taxable income.[28] Thus, Missouri
income taxes are determined with reference to the federal Tax Code.
Under federal law, a taxpayer is allowed to deduct from
taxable income “all the ordinary and necessary expenses paid or incurred during
the taxable year in carrying on any trade or business.”[29] If the amount of
these deductions exceeds taxable income in a given taxable year, the taxpayer has
incurred a “net operating loss.”[30] Section 172 of the Internal Revenue Code
allows a taxpayer in such a situation to apply the unused amount of these
deductions to taxable income in years either immediately before or after the
year in which the loss was incurred.[31] Because this deduction is used to
determine federal adjusted gross income, and Missouri taxes are coupled to
federal adjusted gross income, a Missouri taxpayer must refer to section 172
when calculating Missouri taxes if the taxpayer has incurred a net operating
loss.
B. Brown Group, Inc. v. Administrative Hearing
Commission[32]
In Eilian, the
Supreme Court of Missouri relied on Brown
Group, Inc. v. Administrative Hearing Commission to decide the case. In Brown, a corporate taxpayer attempted to
use a substantial federal net operating loss to offset its Missouri taxable
income – just like the taxpayer in Elian.[33] The Supreme Court of Missouri held that “when a taxpayer incurs a federal loss
its sole recourse is to § 172 [of the Internal Revenue Code].”[34] To hold
otherwise, the court reasoned, would be to “subject a single loss to multiple
use in Missouri without the requisite statutory authority.”[35] In other words,
allowing a taxpayer to use a negative number as the starting point for Missouri
taxes would benefit the taxpayer by giving an incredibly low starting point at
the beginning and then conferring another benefit when additions to the
starting point (Missouri taxable income) are subsumed in the loss. Because there
is no statutory authorization for this double benefit, the Brown court held that a negative number owing to a net operating
loss cannot be used as the starting point for Missouri taxes.[36]
III. Comment
In Eilian, the
Supreme Court of Missouri held that, for purposes of Missouri income taxes,
federal adjusted gross income cannot be a negative number. While this decision
rests on the somewhat complex interaction of federal and state tax law and
policy, the court was also guided by common sense. While it would be possible
to make a hyper-technical argument based on statutory interpretation,[37] the
clear answer is the one arrived at in Eilian:
A taxpayer cannot benefit twice from the same loss. At the federal level, a
taxpayer undeniably recognizes the benefit of the net operating loss deduction. The benefit of the net operating loss deduction is maintained at the state
level as well, because Missouri law takes such a deduction into account by
using the federal adjusted gross income as the starting point for calculating
Missouri taxes. Eilian makes clear
that the only thing that is prohibited is for a taxpayer to reap an additional
benefit unauthorized by law – a very common sense result.
-Keith Holland
[1] No. SC93075 (Mo. June 11, 2013) (en banc), available
at http://www.courts.mo.gov/file.jsp?id=62579.
The West reporter citation is Eilian
v. Dir. of Revenue, 402 S.W.3d 566 (Mo. 2013) (en banc).
[2] Id. at 569.
[3] Id.
[4] Id.
[5] Id. at 572.
[6] Id. at
569-570.
[7] Id. at 567.
[8] Id.
[9] Id.
[10] Brown Group, Inc. v. Administrative Hearing
Commission, 649S.W.2d 874, 876 (Mo. 1983) (en banc).
[11] Id. at 876-877.
[12] Id. at 877.
[13] Id.
[14] Id.
[15] Elian, 402 S.W.3d
at 572.
[[1]6]
Id.
[[1]7]
Id. at 573.
[[1]8]
Id. at 574-575.
[[1]9]
The relevant portion of Mo. Rev. Stat. § 143.431.5 states that “federal taxable
income may be a positive or negative amount.”
[20] Elian, 402 S.W.3d at 574.
[21] Id.
[22] Id. at 575.
[23] Id. at 577.
[24] Id.
[25] Id. at 569.
[26] Id. at 570. Missouri abandoned the “standalone”
approach in favor of the coupled method of determining state income taxes in
1973. See id. at 570, n. 5.
[27] Mo. Rev. Stat. § 143.121.1 (2013).
[28] Id.
[29] 26 U.S.C. § 162(a) (2013).
[30] Id. at § 172(c).
[31] 26 U.S.C. § 172(a) (2013).
[32] 649 S.W.2d 874 (Mo. 1983) (en banc).
[33] Id. at 875-876.
[34] Id. at 877.
[35] Id.
[36] Id.
[37] Such an argument was raised by the taxpayer and
rejected by the court in Brown. See Brown Group, Inc. v. Administrative Hearing
Commission, 649 S.W.2d 874, 876-77 (Mo. 1983) (en banc).
