NOL Net Operating Loss Carryback Ruling

Failure to follow IRS procedure prevented use of longer NOL carryback

Tualatin Valley Builders Supply, Inc. v. U.S. 101 AFTR 2d ¶ 2008

Mike Habib, EA

The Ninth Circuit, affirming a district court, has held that a taxpayer could not use the special 5-year carryback period that applied for net operating losses arising in tax year 2001 because the taxpayer did not follow IRS procedures for choosing that carryback period.

Dispute over 5-year carryback period. Tualatin Valley Builders Supply, Inc. (Tualatin), now dissolved, was seeking a refund of $366,043 of corporate income taxes assessed and collected from it for ’96, plus interest. It filed a claim for refund of the ’96 taxes with IRS in 2004. After IRS denied the claim and Tualatin lost administrative appeals, Tualatin went to district court.

Before the district court, Tualatin said it was entitled to claim an NOL carryback from its tax year ending Mar. 31, 2001, to its tax year ending Dec. 31, ’96. IRS argued that Tualatin lost the opportunity to use the 5-year carryback period because it didn’t timely elect to claim it.

Underlying facts. Tualatin timely filed its 2001 Form 1120 on Oct. 15, 2001 after getting an extension. At that time, it elected to utilize the 2-year carryback period for its NOL under Code Sec. 172(b)(1)(A). This election entitled Tualatin to choose between either amending its return for the year to which the NOL was being carried back in accordance with Code Sec. 6511, or filing for a tentative carryback adjustment for its NOL under Code Sec. 6411(a) . It chose to file for a tentative carryback adjustment. IRS granted the tentative carryback application and Tualatin received what is colloquially referred to as a “quickie refund” for the carryback of the 2001 NOL to ’99.

Subsequent law change. Subsequently, in March 2002 [see Federal Taxes Weekly Alert 3/14/2002], Congress, in the Job Creation and Worker Assistance Act of 2002 (JCWAA), changed the law to provide an elective 5-year carryback period for NOLs arising in tax years ending in 2001 or 2002. (Code Sec. 172(b)(1)(H)) In mid-2002, IRS issued Rev Proc 2002-40, 2002-1 CB 1096, which addressed how a taxpayer who had already filed tax returns for 2001 or 2002 and had already elected a strategy for NOL carrybacks, could take advantage of the new March 2002 law (see Federal Taxes Weekly Alert 5/30/2002).

Specifically, Rev Proc 2002-40, Sec. 5.01 stated that a taxpayer (such as Tualatin) who had previously filed an application for a tentative carryback adjustment (whether or not IRS had acted upon it) or an amended return using a 2-year carryback period for an NOL incurred in a tax year ending in 2001 or 2002, and that did not elect to forgo the 5-year carryback period under Code Sec. 172(j), could use the 5-year carryback provided under Code Sec. 172(b)(1)(H) by following the procedures of Rev Proc 2002-40, Sec. 7 on or before Oct. 31, 2002.

Rev Proc 2002-40, Sec. 7 provided that corporations seeking to choose the 5-year carryback period had to file either a Form 1139, Corporation Application for Tentative Refund, or Form 1120X, Amended U.S. Corporation Income Tax Return. Rev Proc 2002-40, Sec. 5 explicitly required one of these two forms to be filed by Oct. 31, 2002 in order for a taxpayer to elect the 5-year carryback.

Action taken after deadline expired. IRS released Rev Proc 2002-40 on May 23, 2002 and published it in the Internal Revenue Bulletin on June 10, 2002. Tualatin attempted to amend its filing to take advantage of the new 5-year carryback by filing an amended return (Form 1120X) for the ’96 tax year, on Jan. 7, 2003, over two months after the Oct. 31, 2002, deadline for such amendments established by Rev Proc 2002-40, Sec. 5. Because Tualatin acted after this deadline expired, IRS sought to have the case dismissed.

District court sided with IRS. The district court sided with IRS after pointing out that Code Sec. 172(j) provided that the election was to be made in such manner as IRS may prescribe and was to be made by the due date (including extensions of time) for filing the taxpayer’s return for the tax year of the NOL. It also provided that the election, once made for any tax year, was irrevocable for that year. The court said that this language clearly gave IRS the explicit authority to determine how and when the election was to be made and that IRS exercised this authority by publishing Rev Proc 2002-40 . The instructions prescribed by IRS established the deadline of Oct. 31, 2002, for electing the five-year carryback. Rev Proc 2002-40 made it clear that unless the taxpayer followed the procedures of Rev Proc 2002-40, Sec. 7, the taxpayer would be considered to have made an election under Code Sec. 172(j) to forgo the 5-year carryback period in favor of the 2-year carryback period.

Ninth Circuit affirms. Before the Ninth Circuit, Tualatin argued that neither Code Sec. 172(j) nor a Congressional Letter to IRS on the intent concerning the carryback provision, directed IRS to issue rules specifically related to a taxpayer that filed an application for tentative adjustment under the 2-year carryback rule and then sought to apply the 5-year net operating loss carryback rule. The Ninth Circuit said that Congress authorized IRS, both generally and specifically, to promulgate rules implementing the new five-year carryback period. IRS did so in Rev Proc 2002-40 , which established an Oct. 31, 2002, deadline for taxpayers in Tualatin’s position. The Ninth Circuit said that this deadline was consistent with the text of the statute and the authority Congress conferred on IRS. Moreover, Congress implicitly ratified Rev Proc 2002-40 when it made technical changes to the 5-year carryback provision in the Working Families Tax Relief Act of 2004 while leaving Rev Proc 2002-40 untouched.

The Court also held that because Rev Proc 2002-40 did not prohibit a taxpayer from filing a claim for refund in the absence of compliance, it neither shortened the period for filing a claim for refund or credit under Code Sec. 6511(d)(2)(A) nor conflicted with Code Sec. 6511(d)(2)(B)(i), which mandates that a refund from a carryback be allowed even if otherwise prevented by operation of law. Accordingly, it agreed with the district court that Tualatin’s refund claim for ’96 was untimely.

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