Lack of Limitation Period on Certain Adjustments Affirmed in Recent Decision

By Lewis J. Fernandez, J.D., MBA, and Michael A. Urban, J.D., MLT, Washington, DC

A tax attribute carried over from a prior tax year may need to be adjusted because of overlooked or misstated deductions or credits. IRS guidance allows both the IRS and taxpayers to adjust net operating losses (NOLs) and credit carryovers from both open and closed tax years.

For example, in Rev. Rul. 81-88 the taxpayer carried back an NOL from 1977 to 1974, 1975, and 1976. However, for 1974 an unclaimed deduction barred by the period of limitation on refund claims resulted in an NOL for that year. The IRS held that the taxpayer could carry the 1974 loss forward and apply it as an adjustment decreasing taxable income for 1975, prior to applying the 1977 NOL carryback to 1975.

Supreme Court Precedent

The principle discussed in Rev. Rul. 81-88 and utilized to allow the adjustment in otherwise closed years is based on the Supreme Court’s opinion in Lewis, 284 U.S. 281 (1932). In that case, the IRS had examined the taxpayer’s return and assessed a deficiency. The taxpayer paid the deficiency and made a claim for refund. The IRS disallowed the claim and issued a revised computation that allowed some previously disallowed deductions but determined a greater tax liability than was indicated prior to the refund claim being made.

The Supreme Court held that the IRS has authority in acting on a claim for refund to redetermine tax after the limitation period on assessment had run. The court stated that a refund claim involves a redetermination of the entire tax liability and that, while no new assessment can be made after the limitation period expires, the taxpayer is not entitled to a refund unless there has been an overpayment of tax.

R.H. Donnelley

A recent opinion filed by the U.S. District Court for the Eastern District of North Carolina illustrates that the principle set forth in Lewis applies even for the limitation period on assessment for the year in which excess carryback credits arise.

In R.H. Donnelley Corp., No. 5:08-cv-501 (E.D.N.C. 1/29/10), appeal docketed, No. 10-1365 (4th Cir. 4/1/10), the taxpayer timely filed a consolidated tax return for its 1994 tax year. Examining the 1994 return, the IRS did not determine any tax deficiencies prior to expiration of the limitation period on assessment. Subsequently, the taxpayer filed refund claims for its 1991 and 1992 tax years. The claim for refund for the 1991 tax year was based on unused research credits from the 1994 year; the claim for refund for the 1992 tax year was based on unused foreign tax credits from the 1994 year.

In response to the taxpayer’s refund claims, and after the limitation period on assessment for the 1994 tax year had expired, the IRS sent the taxpayer a statement of income tax changes that determined an increase in tax for the 1994 tax year. The statement asserted that the IRS would not assess additional tax due to the expired limitation period. However, the IRS statement noted that the unassessed tax liability for 1994 caused all the 1994 research and foreign tax credits to be used in that year and left the taxpayer no excess credits to carry back to the 1991 or 1992 tax years.

The taxpayer conceded that when a refund is claimed, Lewis permits the IRS to conduct an examination of the tax year to which the claim relates to ensure that an overpayment does in fact exist. However, the taxpayer argued that because the IRS examination of 1994 occurred after the limitation period on assessment for that year had expired, the IRS could examine returns only for the 1991 and 1992 tax years and that the IRS must accept any carryback amounts from other years as they were stated when the limitation period on assessment expired.

The district court held for the government, stating that while the IRS did not have authority to assess and collect additional taxes for 1994, it could consider the 1994 tax year to determine whether the carryback of credits to the 1991 and 1992 tax years was proper. The court noted that otherwise the taxpayer could benefit twice from the 1994 underpayment of tax: avoiding tax in the 1994 tax year and seeking a refund from the carryback of credits from the 1994 tax year that would not have existed had the taxpayer’s tax liability for the 1994 tax year been computed properly.


The Donnelley opinion illustrates that courts may sustain the government when it makes adjustments to closed years only to determine whether an overpayment of tax exists, and not to recover additional taxes beyond the limitation period on assessment. In this case, the IRS was using Lewis as a shield to protect the government from having to issue unearned refunds. The IRS was not using the Supreme Court precedent to forge a “sword” with which it might attempt to assess and collect additional taxes in spite of the expiration of the limitation period. It remains to be seen whether this principle will be sustained on appeal.

Editor: Annette B. Smith, CPA


Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.

For additional information about these items, contact Ms. Smith at (202) 414-1048 or

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