The KBTA Holds That a Limited Liability Company May Not Offset Income with a Carry Forward of Net Operating Losses Generated Prior to 2005
In HPCKAL, LLC v. Dep’t of Revenue, File No. K09-R-27 (KBTA August 25, 2011); on appeal, Civil Action No. 11-CI-1417 (Franklin Cir. Ct.), the Kentucky Board of Tax Appeals (“KBTA”) held that a limited liability company (“LLC”) was not entitled to offset its income for 2005 and 2006 with a carry forward of net operating losses (“NOLs”) that it generated in 2002 and 2003 because prior to 2005, only LLC members, not the entity, were permitted to carry forward unused NOLs from a particular year to offset income in future years.
HPCKAL, LLC (“HPCKAL”) sought to offset its income for 2005 and 2006 with NOLs it generated in 2002 and 2003. Prior to the Kentucky Tax Modernization Act (“Act”) in 2005, LLC members were permitted to carry forward any unutilized NOLs from a particular year to offset income in future years. However, effective 2005, the Act amended the definition of “corporation” in KRS 141.010 to encompass most types of businesses, including LLCs, and thus the Kentucky Department of Revenue (the “Department”) began to tax pass-through entities such as LLCs, at the entity level.
The Department disallowed HPCKAL’s attempt to use the NOLs in 2005 and 2006 under the theory that the Act did not expressly permit an LLC to use NOLs from years prior to 2005 to offset income earned in 2005 and 2006. HPCKAL appealed this decision to the KBTA.
As a preliminary matter, the KBTA found that HPCKAL had no NOLs remaining, but the members did. Moreover, the KBTA found that the change in the law under the Act to effectively treat HPCKAL as if it elected to be treated as a C Corporation in 2004 was clear. It further found that even if the amendments were ambiguous with regard to HPCKAL’s ability to utilize NOLs belonging to its members, any ambiguity must be resolved against HPCKAL because tax exemptions, deductions or credits, such as NOL deductions, must be strictly construed against the taxpayer.
Further, the KBTA held that under Johnson Controls v. Miller, 130 S.Ct. 3324 (2010), HPCKAL “had no vested right to use the NOLs for the years in question” and thus the Department’s denial of the NOL deductions was appropriate. Therefore, the NOLs had to remain with the members of the LLC and could not be transferred to HPCKAL for use in 2005 and 2006, but because the Act was repealed in 2007, HPCKAL’s members would be able to utilize the remaining NOLs in 2007 and years thereafter.