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Rules for NOL-Triggered Refunds Could Endanger Some Credits

Posted on June 11, 2020

The IRS’s “chain of causation” approach for minimum tax credit refunds that are attributable to net operating loss carrybacks could prove beneficial amid the pandemic, but might foreshadow an unsettling fate for foreign tax credits.

In a legal memorandum (ILM 202023006) dated March 6 and released June 5, the IRS traced an overpayment through a cascading chain to an originating tax attribute to determine whether the special limitations period rule for overpayments under section 6511(d)(2) applies to repayments for an alternative minimum tax credit that resulted from an NOL carryback.

That decision resolving contradictory law on the meaning of “attributable to” is welcome guidance for taxpayers, many of whom believe the approach taken in the legal memorandum was the most reasonable and correct in determining whether the statute of limitations remained open to claim a refund attributable to AMT credits that arise because of an NOL carryback, Kevin M. Jacobs of Alvarez & Marsal Taxand LLC told Tax Notes.

According to Bryon Christensen of EY, the guidance “provides additional clarity on the application of a binary statute of limitations issue [and] promotes consistency between tax positions from year to year.”

The statute of limitations for claiming a credit or refund of an overpayment of taxes under section 6511(a) is generally within three years from when the return was filed or two years from when the tax was paid, whichever is later.

Section 6511(d)(2) sets forth exceptions for claims for credits or refunds that relate to an overpayment attributable to an NOL or capital loss carryback, which provide that the three-year limitation period starts from the due date for filing the tax return for the year of the NOL, rather than the year in which the carryback results in a refund.

Originating Cause Triumphs

Under the facts of the memorandum, the taxpayer’s payment on an asbestos personal injury claim resulted in an NOL in year 11, of which a portion could be carried back 10 years under former section 172(b)(1)(C) and 172(f)(1)(A) for specified liability losses, which was repealed by the Tax Cuts and Jobs Act.

In year 12, the taxpayer filed an amended return carrying back the NOL to year 1, which triggered an AMT liability for that year, which the taxpayer paid. The AMT payment generated a credit carryforward to year 3 under former section 53, resulting in an overpayment, for which the taxpayer filed a claim for refund in year 12 under section 6511(d)(2) as attributable to the NOL carryback from year 11.

The question the IRS addressed was whether the overpayment is considered attributable to the year 11 NOL and therefore eligible for the special limitation period that begins in that year, rather than attributable to the AMT credit and subject to the general rule of filing a refund claim within three years from when the year 3 return was filed. The latter interpretation would result in an untimely refund claim for the taxpayer, with the answer depending on what “attributable to” means.

In resolving how “attributable to” should be interpreted — considering three possible interpretations — the IRS analyzed case law and legislative history because neither the code nor the regulations provided a definition.

The IRS considered whether an overpayment is attributable to the tax attribute immediately causing the overpayment (the AMT credit carryforward for year 1), to any tax attribute to which the overpayment can be traced, or to only the originating cause, which would be the NOL carryback from year 11.

The IRS explained that “in a true chain-of-causation scenario, an NOL carryback releases another tax attribute (such as a foreign tax credit, minimum tax credit or general business credit) in the carryback year that is carried to another year to create an overpayment.”

The legal memorandum concluded that section 6511(d)(2) encompasses “any overpayment that can be traced to the NOL carryback when an NOL carryback begins a chain of causation involving other tax attributes.”

“While at first glance the ‘chain of causation’ standard [the memorandum] adopts may seem a little vague, in practice it hopefully will prove straightforward to administer as taxpayers are very familiar with identifying the year-over-year correlative effects of an adjustment to an NOL or other tax attribute,” Christensen said.

CARES Act Connection

The facts of the memorandum— a taxpayer with a specified liability loss that can be carried back 10 years — accentuate the importance of the government’s potential theories for determining what “attributable to” means, Brian A. Peabody of EY told Tax Notes. With that long of a carryback period, there is a fairly high likelihood that most of those intervening years are closed, which means that if the IRS took a different position, the taxpayer wouldn’t have gotten the benefit of the freed-up minimum tax credits, he explained.

Peabody pointed out that in contrast, under the pre-TCJA general two-year carryback rule, if a taxpayer has an NOL in year 3 that’s carried back to year 1 — which frees up credits that are carried forward — there’s “probably a good chance that the statute is open for that intervening year.”

The five-year carryback rule under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) for losses arising in tax years 2018 through 2020 is “not quite as problematic as the specified liability losses, and it’s not quite as non-problematic as the regular NOL,” Peabody said. But he noted that in some situations, if the IRS chose a different position in the legal memorandum, a taxpayer carrying back a CARES Act NOL could be precluded from taking the resulting credits, thus heightening the importance of the IRS’s interpretation amid the coronavirus pandemic as it applies to AMT credits.

Jacobs pointed out that the IRS’s May 27 guidance — questions and answers posted on its website on the ability to claim AMT credits resulting from NOL carrybacks under the CARES Act — appears to have applied the conclusion the agency reached in the recently released legal memorandum.

According to the Q&As, if a C corporation is carrying back all or a portion of a post-2017 NOL to a pre-2018 tax year in which AMT rules apply, the AMT NOL in the post-2017 year is treated as zero for amended returns or for purposes of Form 1139, “Corporation Application for Tentative Refund,” filed on or after June 1.

That means “when a taxpayer carries back its NOL, it is increasingly likely that the carryback will cause the taxpayer to pay alternative minimum tax, generally by way of a reduced refund,” which will in turn generate AMT credits, Jacobs said.

Jacobs said that Q&A No. 4 allows taxpayers to claim refunds as a result of the AMT credits offsetting regular tax liability by claiming them on a Form 1139, “without any mention of the statute of limitations, presumably based on the logic of ILM 202023006.”

Foreshadowing FTC Rules

If a taxpayer carries back an NOL but generates excess FTCs rather than freeing up an AMT credit to carry forward, that represents a different context because the rules aren’t the same, and it could yield an unfavorable-taxpayer result at a time when Congress has intended taxpayers to claim refunds from carryback losses to help manage liquidity.

Under section 6511(d)(3), there’s another special limitation period that applies to credit or refund claims related to overpayments attributable to foreign taxes, which allows taxpayers to file a claim within 10 years from the date for filing the return for the year in which the foreign taxes were paid or accrued.

In Rev. Rul. 71-533, 1971-2 C.B. 413, the IRS concluded that “where a carryback of foreign taxes arises as a result of a net operating loss carryback from a subsequent taxable year . . . a claim for credit or refund on a resulting overpayment of taxes attributable to the foreign tax credit is subject to the ten-year statute of limitations provided by section 6511(d)(3)(A).”

In that ruling, the taxpayer’s refund claim resulted from an NOL it sustained in 1969 that it carried back to clear income tax it owed for 1966, during which it had already claimed an FTC for the foreign taxes it paid that year. By doing so, the entire amount of taxes it paid to foreign countries exceeded the threshold allowable as an FTC for 1966. The taxpayer then carried the excess back to 1964, which resulted in an overpayment for which the taxpayer filed a refund claim that the IRS said was timely under the FTC special limitation period.

However, the IRS informed taxpayers in April (Rev. Rul. 2020-8, 2020-19 IRB 775) that it has suspended the 1971 ruling, and in part Rev. Rul. 68-150, 1968-1 C.B. 564, because it is reconsidering whether the FTC 10-year rule applies in that situation. Those rulings “may not reflect the correct interpretation of section 6511(d)(2),” the IRS said in the legal memorandum.

So it’s possible that the IRS, in applying the chain of causation approach taken in the memorandum, would say that excess FTCs caused by an NOL carryback are subject to the special three-year limitation period under section 6511(d)(2), Jacobs said.

Based on the facts in the 1971 revenue ruling, “if section 6511(d)(3)(A) applies, the taxpayer could file the refund claim 10 years after the due date of its 1966 tax return, whereas if section 6511(d)(2)(A) applies, the taxpayer could file the refund claim three years after the due date of its 1969 tax return,” Jacobs explained.

One practitioner who spoke with Tax Notes following the release of Rev. Proc. 2020-8 noted that the fact pattern being reconsidered seems to result only from the CARES Act’s NOL relief, and said that suspending the favorable guidance “is inconsistent with the relief presumably intended by the temporary NOL rules.”

Beyond Refund Claims

Part of the IRS’s analysis and rationale for concluding that an overpayment is attributable to the NOL carryback if it can be traced through a chain of causation is that Congress wanted symmetry between the limitations period for those overpayments and the period for assessing deficiencies attributable to NOL carrybacks.

Further, the IRS pointed to case law under section 6501(h) that it said “supports tracing deficiencies through a chain back to an originating NOL.”

Christensen warned that the IRS’s signaling that it will use the same logic in the legal memorandum when considering how to apply the statute of limitations on assessment means it "may seek adjustments in an otherwise closed year based upon a similar ‘chain of causation’ theory.”

Jacobs questioned the extent to which the ILM guidance on what constitutes “attributable to” can be applied to other code sections that use the same phrase, such as sections 382(h)(6) and 165(i).

Under section 382(h)(6) loss limitation rules following an ownership change of a loss corporation, items of income that are properly taken into account or amounts allowable as deductions “which [are] attributable to periods before the change date” must be treated as built-in gain or loss, respectively, for the tax year.

Section 165(i) allows taxpayers to take into account “any loss occurring in a disaster area and attributable to a federally declared disaster” in the preceding tax year in which the disaster occurred.

Peabody said it’s interesting to see the government’s thought process, at least regarding section 6511 for what attributable means, while practitioners, taxpayers, and the IRS are all wrestling with the meaning of attributable in the frequently discussed federal disaster loss provision.

Peabody said that in determining losses that would qualify under section 165(i), it is “difficult to say to a high degree of certainty what’s attributable to” the federally declared disaster because the pandemic is unlike traditional disasters in which taxpayers have physical damage to physical property.

It’s a “tumbling of dominoes” with COVID-19 being the first one, but it’s unclear whether it’s sufficient for taxpayers experiencing losses — from shuttering businesses, for example — to trace back to the first domino or if they must look to a later one as the cause of the loss, such as the closing of nonessential businesses by an act of a state governor, Peabody said. Or might it be a different point on the continuum, such as a taxpayer’s decision to abandon an intangible asset? he asked.

The degree of nexus required between the loss and the disaster is what practitioners and taxpayers are struggling with, Peabody said, adding that “reasonable people could reach a different conclusion; hence the need for guidance.”

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