Rev. Rul. 81-88
1981-1 C.B. 585, 1981-11 I.R.B. 48.
Internal Revenue Service
Revenue Ruling
REFUNDS AND CREDITS; CARRYBACK; UNCLAIMED DEDUCTION IN CLOSED YEAR
Published: March 16, 1981
26 CFR 301.6511(d)-2: Overpayment of income tax on account of net operating loss or capital loss carryback
(Also Section 172; 1.172-4.)
Refunds and credits; carryback; unclaimed deduction in closed year. In determining the amount of an overpayment of income tax from a net operating loss carryback that may be refunded or credited, the taxable income of the first carryback year should not be reduced by the amount of an unclaimed deduction that is barred by the expiration of the period of limitations. If an adjustment for a barred deduction in the first carryback year results in a net operating loss for that year, that net operating loss may be carried forward and applied as an adjustment decreasing the taxable income of the next open carryback year prior to applying the net operating loss carryback. Rev. Ruls. 218 and 65-96 revoked.
ISSUE
For the purpose of determining the amount of an overpayment of income tax attributable to a net operating loss carryback that may be refunded or credited, should the taxable income of the first carryback year be reduced by the amount of an unclaimed deduction when allowance of refund or credit of an overpayment attributable to such deduction is barred by the expiration of the period of limitations under section 6511(a) of the Internal Revenue Code? Also, what are the income tax consequences in the event that adjustment for a barred deduction in the first carryback year results in a net operating loss for that year?
FACTS
Situation 1. M, a domestic corporation, incorporated January 6, 1974, files its return on a calendar year basis. M timely filed its 1974 income tax return reporting taxable income of 100x dollars and paid tax of 40x dollars. M timely filed its 1975 income tax return reporting taxable income of 150x dollars and paid tax of 60x dollars. M's 1977 income tax return showed a net operating loss of 165x dollars. On June 1, 1978, M filed a Form 1120X, Amended U.S. Income Tax Return, for 1974 on which it claimed the 1977 net operating loss deduction, in accordance with the provisions of section 172 of the Code. On September 8, 1978, an audit of M's 1974, 1975, 1976 and 1977 income tax returns revealed that M failed to claim a deduction of 20x dollars on its 1974 return. No other adjustments were found. The period of limitation for filing a claim for credit or refund for the unclaimed deduction of 20x dollars expired on March 15, 1978.
Situation 2. Same as Situation 1, except that (1) the amount of deduction that M failed to claim on its 1974 income tax return was 220x dollars and (2) on December 15, 1978, M filed for both 1975 and 1976, a Form 1120X, Amended U.S. Income Tax Return, on which M claimed the 1974 and 1977 net operating loss deductions, in accordance with the provisions of section 172 of the Code.
LAW AND ANALYSIS
Section 6511(a) of the Code provides that a claim for credit or refund of the overpayment of any tax imposed by the Code in respect of which the taxpayer is required to file a return shall be filed by the taxpayer within three years from the time the return was filed or two years from the time the tax was paid, whichever of such periods expires the later.
For carrybacks arising in taxable years beginning on or before November 10, 1978, section 6511(d)(2) of the Code provides that if a claim filed by a corporation relates to an overpayment attributable to a net operating loss carryback, in lieu of the three year period prescribed in section 6511(a), the period shall end with the expiration of the 15th day of the 39th month following the end of the taxable year of the net operating loss which results in the carryback, or the period prescribed in section 6511(c) in respect of such taxable year, whichever expires later.
Section 301.6511(d)-2(a)(3) of the Regulations on Procedure and Administration provides that if a claim involves an overpayment based not only on a net operating loss carryback but also on other items, and if the claim with respect to any items is barred by the expiration of any applicable period of limitation, the portion of the overpayment attributable to the items not so barred shall be determined by treating the allowance of such items as the first adjustment to be made in computing such overpayment.
In Lewis v. Reynolds, 284 U.S. 281 (1932), Ct.O. 443, X1-1 C.B. 130 (1932), the Commissioner audited petitioner's return and assessed a deficiency. Petitioner paid the deficiency and asked for a refund. The Commissioner denied this request and issued a revised computation that allowed some previously denied deductions, but showed a greater tax liability than before. The Supreme Court held that the Commissioner had the authority in acting upon a claim for refund to redetermine and reassess the tax after the
statute of limitations ran. The Court stated that a claim for refund involves a redetermination of the entire tax liability, and that while no new assessment can be made after the statute of limitations has expired, the taxpayer is not entitled to a refund unless there has been an overpayment of tax.
Section 172(b)(2) of the Code provides, in general, that the entire amount of the net operating loss for any taxable year (the loss year) shall be carried to the earliest taxable year to which such loss may be carried (by reason of section 172(b)(1)). The portion of such loss which shall be carried to each of the other taxable years shall be the excess, if any, of the amount of such loss over the sum of the taxable income for each of the prior taxable years to which such loss may be carried. (Taxable income for purposes of section 172(b)(2) is computed with certain specified modifications from its definition in section 63.)
Several court decisions indicate that taxable income for purposes of section 172(b)(2) of the Code means correct taxable income. See, e. g., Springfield Street Railway Co. v. United States, 312 F.2d 754 (Ct.Cl.1963); Commissioner v. Van Bergh, 209 F.2d 23 (2d Cir. 1954); Phoenix Coal Co. v. Commissioner, 231 F.2d 420 (2d Cir. 1956); State Farming Co. v. Commissioner, 40 T.C. 774 (1963); ABKCO Industries, Inc. v. Commissioner, 56 T.C. 1083 (1971), aff'd on other grounds, 482 F.2d 150 (3d Cir. 1973). Cf. Rev. Rul. 74-61, 1974-1 C.B. 239, in which it was concluded that taxable income for any base period year that is barred by the statute of limitations for assessment or refund must be adjusted (where necessary) to arrive at the correct taxable income for such year in determining the base period for income averaging purposes.
Section 306.6511(d)-2(a)(3) of the regulations provides that the adjustment for a net operating loss deduction that is not barred by the statute of limitations should be the first adjustment made where there are barred items as well in the claim for refund. For purposes of determining the amount of the net operating loss that M may carry back to the second carryback year "taxable income" as used in section 172(b)(2) of the Code means reported taxable income (with such modifications as specified in section 172(b)(2)). This construction of section 172(b)(2) is in harmony with section 6511(d), as interpreted by section 301.6511(d)-2(a)(3) of the regulations.
In accordance with section 301.6511(d)-2(a)(3) of the regulations, if a net operating loss is carried back to a year in which there is a barred adjustment decreasing taxable income, the net operating loss shall be the first adjustment to reported taxable income. If there are barred adjustments increasing taxable income, these adjustments to taxable income will be made as a set-off against the net operating loss. Commissioner v. Van Bergh; Phoenix Coal Co. v. Commissioner. See generally Lewis v. Reynolds. Any barred adjustments decreasing taxable income will be allowed in the carryback year only as counteradjustments to normally barred adjustments increasing taxable income, which must be made for the purpose of determining whether a taxpayer has in fact overpaid.
In Springfield Street Railway Co. any allowance of an overpayment in the first net operating loss carryback year was barred for either (1) the net operating loss carryback or (2) other adjustments that would have properly decreased taxable income. The question in Springfield was how much of the net operating loss deduction was to be carried over to the second carryback year. The court allowed the taxpayer to utilize a barred deduction in order to lower taxable income for the first carryback year. This resulted in a smaller amount of the net operating loss carryback being used in the first carryback year and a greater amount of the carryback consumed in the second carryback year, a year that was still open for net operating loss carryback refund purposes. In this revenue ruling, the allowance of an overpayment in the first net operating loss carryback year due to a net operating loss carryback is not barred.
In determining the amount of a net operating loss that may be carried from a closed year forward to an open year, the special rules of section 301.6511- 2(a)(3) of the regulations do not apply. Since the net operating loss for the closed year (1974) is based upon items arising in the closed year, all adjustments to taxable income, whether or not barred by the statute of limitations, will be taken into account and the amount of the net operating loss carryover will be determined under the rules of section 172 of the Code.
HOLDINGS
Situation 1. For the purpose of determining the amount of the overpayment due to M's 1977 net operating loss carryback, the taxable income for 1974 should not be reduced by the amount of the barred deduction. Neither will the barred deduction be taken into account in determining the amount of the 1977 net operating loss deduction to be carried to 1975. Therefore, M is entitled to a refund or credit of 40x dollars for 1974, and the amount of the 1977 net operating loss to be carried to 1975 is 65x dollars (1977 net operating loss of 165x dollars less 1974 taxable income of 100x dollars). Thus, a taxpayer will not be penalized to the extent barred adjustments decrease income for the year of the refund.
Situation 2. In addition to the refund or credit of 40x dollars to which M is entitled in Situation 1, M is entitled to claim in 1975 a deduction for a net operating loss deduction in 1974 of 120x dollars (barred adjustment decreasing 1974 taxable income of 220x dollars less taxable income shown on 1974 return of 100x dollars), representing the amount of the net operating loss carryforward from 1974. Therefore, for 1975 M will apply the 1974 net operating loss carryover of 120x dollars as an adjustment decreasing the taxable income income of 150x dollars prior to applying the net operating loss carryback from 1977 of 65x dollars. For the year 1976 M is entitled to a net operating loss carryback deduction from 1977 of 35x dollars (1977 net operating loss of 165x dollars less 100x dollars applied in 1974 less 30x dollars applied in 1975).
Where a taxpayer has filed a timely claim for refund based on an adjustment, other than a net operating loss carryback adjustment, and there are other adjustments that are barred, see Rev. Rul. 81-87, page, this Bulletin. That ruling holds that, if there has been an overpayment of tax, the amount of the credit or refund is based upon the lesser of either the excess amount of income on which tax was paid or the amount of income for which the taxpayer has made timely claims. Here, the excess amount on which tax was paid was 100x dollars and the amount of income for which the taxpayer has made timely claims is 100x dollars. Thus, allowance of a refund of 40x dollars for 1974 is consistent with Rev. Rul. 81-87.
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 218, 1953-2 C.B. 176, and Rev. Rul. 65-96, 1965-1 C.B. 126, holding that adjustments decreasing liability by allowing
normally barred deductions must be made as matter of general procedure, are hereby revoked.
Rev. Rul. 81-88, 1981-1 C.B. 585, 1981-11 I.R.B. 48.