Special Limitation Periods for Carryback Assessments

Editor: Annette B. Smith, CPA

Procedure & Administration

If a net operating loss (NOL) or capital loss has been carried back on Form 1120X, Amended U.S. Corporation Income Tax Return, Sec. 6501(h) provides that a deficiency in tax attributable to the carryback can be assessed based on the limitation period for the year of the loss, rather than on the limitation period for the carryback year. Sec. 6501(j) provides the same rule in the case of business credit carrybacks.

If an NOL, capital loss, or business credit carryback has instead been carried back on Form 1139, Corporation Application for Tentative Refund, Sec. 6501(k) provides a rule that is somewhat more favorable to the IRS. The limitation period within which the IRS can assess a deficiency for the carryback years still is determined by reference to the limitation period for the year of the loss or credit, but the deficiency does not have to be attributable to the carryback. Instead, the deficiency can result from general adjustments to the carryback year itself; however, the amount of the deficiency that can be assessed is limited to the amount of the tentative allowance received by the taxpayer. If the deficiency in the carryback year is attributable to both the carryback and current-year adjustments, Sec. 6501(k) provides that the portion attributable to the carryback is assessed first (see the example in Regs. Sec. 301.6501(m)-1(a)(2)).

Impact of Carryback Method

A common perception is that claiming a carryback refund on Form 1120X results in less exposure to the taxpayer, since once the normal limitation period on assessment for the carryback year has expired, the only deficiency that can be assessed for that year is one attributable to the loss or credit carryback. While as a technical matter that observation is correct, as a practical matter the outcome for the taxpayer is likely to be the same regardless of how its loss or credit is carried back. This is because:

• In almost all cases the IRS considers the merits of a carryback claim filed on Form 1120X before it issues the requested refund; and
• The IRS may reduce or eliminate such refund based on the Lewis v. Reynolds doctrine.

In Lewis v. Reynolds, 284 U.S. 281 (1932), the Supreme Court held that the ultimate question presented in a refund claim is whether the taxpayer has overpaid its tax. The IRS may therefore reconsider the taxpayer’s entire return for each year that a refund or credit of an alleged overpayment is sought, even to the extent of making adjustments such as disallowing deductions that previously had been erroneously allowed (and thereby reducing or eliminating the claimed refund). Such reconsideration, however, is permitted only for the purpose of determining whether there has been an overpayment and does not authorize an additional assessment barred by the running of the statute of limitation under Sec. 6501. Therefore, in a Form 1120X carryback situation to which Sec. 6501(h) or (j) applies, the IRS, by exercising its setoff authority under Lewis v. Reynolds, can achieve the same result that would be obtained in the case of a tentative carryback governed by Sec. 6501(k).

Example: Taxpayer V carries back a 2007 NOL to 2005 on Form 1139 and obtains a tentative refund of $50x. After the normal three-year period of limitation on assessment has expired for 2005, but while it is still open for 2007, the IRS determines that the NOL is correct but that V overstated its 2005 deductions by $100x. Under Sec. 6501(k), the IRS can assess the resulting tax deficiency of $35x for 2005, in which case V will end up with a net refund of $15x (ignoring underpayment and overpayment interest).

If V instead claims the $50x carryback refund for 2005 on Form 1120X, the IRS cannot make an assessment for 2005 under Sec. 6501(h) because the $35x deficiency is attributable to overstated deductions for 2005 rather than to the 2007 carryback. However, under Lewis v. Reynolds, the IRS can reduce the claimed carryback refund of $50x by the $35x, again resulting in a net refund of $15x.

EditorNotes

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 annette.smith@us.pwc.com.

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.