Indiana enacts corporate income tax changes

In brief

S.B. 419 enacts several changes to Indiana's corporate income tax, including:

• an update to IRC conformity
• changes to the calculation of an Indiana net operating loss (NOL)
• guidance regarding applying IRC Section 382 and Section 108 treatment to Indiana NOLs
• federal consolidated return regulation treatment for certain consolidated/combined NOL matters
• effectively decoupling from TCJA Section 174 treatment.

The takeaway: The statutory changes for NOLs may result in significant modifications to the operation and calculation of a taxpayer’s Indiana’s NOL, particularly with respect to apportioning the IRC Section 382 limitation using the apportionment percentage for the year in which the NOL is being claimed.

The new law allows an immediate expensing for R&E expenses charged to a capital account under IRC Section 174(a)(2)(A) retroactively for tax years beginning after December 31, 2021.

[Indiana S.B. 419 (5/4/23)]

Net operating loss changes

Applicable to tax years beginning after December 31, 2022, Indiana introduces two new terms for use in calculating a taxpayer’s Indiana NOL: (1) separately stated net operating loss and (2) preliminary federal net operating loss.

Generally, a separately stated net operating loss means a “federal net operating loss, or a portion of a federal net operating loss, determined according to the Internal Revenue Code that is computed as an allowable federal net operating loss with regard to a taxable year; and required to be carried forward or carried back under the Internal Revenue Code; regardless of whether the taxpayer had federal taxable income for the year of the loss.”

Generally, a preliminary federal net operating loss has a different meaning depending on whether a taxpayer has a federal net operating loss. For a corporate taxpayer with a federal NOL, the preliminary federal net operating loss is the taxpayer’s federal NOL. For a corporate taxpayer that does not have a federal NOL, the preliminary federal net operating loss is the corporation’s “federal taxable income as defined in Section 63 of the Internal Revenue Code.”

Observation: Application of the new definitions, and of other new elements of Indiana’s NOL, are complex. Additional guidance may be issued by the Department. It appears that the changes are directed toward addressing corporate taxpayers that do not have a federal NOL but – due to Indiana modifications – have an Indiana NOL. The new treatment appears to allow for adjustments to the Indiana NOL that mirror federal treatment when a federal taxpayer had an NOL.

NOL treatment – IRC Section 108

Applicable to tax years beginning after December 31, 2022, a taxpayer with excluded income from the discharge of indebtedness under IRC Sections 108(a)(1)(A)-(C) reduces its Indiana NOL by the remainder of:

• the amount of discharge of indebtedness excluded from federal gross income derived from Indiana sources; minus
• the amount of discharge of indebtedness derived from Indiana sources that reduced the tax attributes under IRC Sections 108(b)(2)(D)-(F) or was applied for federal tax purposes under IRC Section 108(b)(5).

Any reduction in an Indiana NOL shall first be applied to the Indiana NOL for the tax year of the discharge, and then to any Indiana NOL carryovers.

The provisions of IRC Sections 108(d)(6) and (7) apply to any discharge of indebtedness for purposes of determining the reduction of NOLs under this section of the new law.

Observation: This update provides clarity for how Indiana NOLs may be adjusted as a result of excluded income from the discharge of indebtedness under IRC Sections 108(a)(1)(A)-(C).

Section 174 treatment

Prior to the TCJA, Section 174 allowed taxpayers a current-year deduction for research or experimental expenditures with an election to treat such expenses as deferred expenses that are deducted ratably over at least 60 months.

The TCJA requires that, applicable for the 2022 tax year, such expenses are capitalized expenses and amortized over five years (15 years for expenses attributable to foreign research).

Prior to S.B. 419, Indiana’s general conformity to the IRC may have resulted in Indiana’s conformity to the Section 174 TCJA changes requiring capitalization.

Under S.B. 419, applicable to tax years beginning after December 31, 2021, taxpayers make the following modifications to adjusted gross income:

• a subtraction for R&E expenses charged to a capital account under Section 174(a)(2)(A)
• an addition for the amount deducted under IRC Section 174(a)(2)(B) for the tax year.

Additionally, an R&E expense for Indiana purposes “does not include expenditures for which a deduction is disallowed as a result of Section 280C(c) of the Internal Revenue Code.”

Observation: The S.B. 419 changes effectively allow Indiana taxpayers to treat Section 174 expenses as they were treated prior to the enactment of the TCJA. Note that the change is retroactive to the 2022 tax year. S.B. 419 also provides specific Section 174 treatment regarding passive income and for owners of flow-throughs.