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Grab Bag: Increased Penalties for Failure to File and No Financial Disability For NOL Carryback Elections

Posted on Feb. 29, 2016

Court of Federal Claims Declines to Apply Financial Disability Tolling Rule for NOL Carrybacks

Both Keith and Carl have written often on some of the procedural wrinkles with Section 6511(h), the provision that tolls the refund statute in periods of financial disability. This past week in McAlister v US, the Court of Federal Claims declined to allow taxpayers to use the financial disability exception of section 6511(h) to extend the due date by which the taxpayers could have elected to apply a net operating loss from 2009 and carry back their loss to an earlier year, 2005.

The Code has special rules for refunds based on carrybacks. As McAllister describes, a “claim for refund is ordinarily timely if it is filed within three years of the date of the filing of the tax return or within two years of the date of the payment of the tax. 6511(a). If the basis for a refund is an NOL carryback (as it was here), the time period for filing the refund claim is three years from the due date for the return for the taxable year in which the NOL arose. § 6511(d).”

I will discuss the case and the issues briefly below.

In McAllister the taxpayers argued that they were financially disabled because they were “unable to manage [their] financial affairs by reason of a medically determinable physical or mental impairment” during 2009 and 2010. Specifically, they claimed that Mr. McAllister had a “recurring eye illness and other conditions throughout those years, and Mrs. McAllister suffered from debilitating symptoms which were eventually diagnosed as a tumor of the neck.” The McAllisters claimed that they had losses in 2009 which could be carried back to 2005, which resulted in after application a reduction in 2005 liability of over $175,000.

Special carryback rules enacted in 2009 extended the normal period to carryback losses from two years to five. The opinion discusses those rules and how they apply:

The American Recovery and Reinvestment Act of 2009 (“ARRA”), 26 U.S.C. § 172(b)(1)(H), permitted small business owners to carry back operating losses in 2009 for up to five years, three years more than otherwise would have been permissible. See 26 U.S.C. § 172(b)(1)(A) (2012) (providing the general rule that a net operating loss may be carried back two years prior to the year of the loss). In plaintiffs’ case, this would have allowed the McAllisters to carry back the 2009 NOLs to the 2005 tax year, resulting in a reduction in their 2009 liability of $175,013. The Act provided, however, that “[a]ny election under this subparagraph shall be made … by the due date (including extension of time) for filing the taxpayer’s return for the taxable year of the net operating loss [i.e., 2009, not 2005].”

The McAllisters were over a year late in filing their 2009 return and argued that the 6511(h) tolling provision for financial disability could act to have extend the date for filing the 2009 tax return that generated the NOL carryback. The court (without commenting on the adequacy of whether the taxpayers established that they were financially disabled) said no because the 6511(h) special rule on disability only acts to toll refund claims not carryback elections:

As defendant points out, there are two separate time periods at play: the period of limitations for filing a refund claim under section 6511, and the time within which the NOL carryback election must be made. Defendant contends that the period of limitations for filing a refund claim under 6511 is irrelevant to the dispute. Rather, the election for the NOL carryback provided in section 172(b)(1)(H) is clearly spelled out in the statute as being the time period for filing a timely return for the year in which the loss is incurred, i.e., 2009. Section 6511(h) does not operate to remedy this failure, as it only applies to subsections (a) through (c) of section 6511. We agree.

Higher Penalties for Failing to File Returns

This past week the President signed into law H.R. 644, the Trade Facilitation and Trade Enforcement Act of 2015. The law provides for stiffer penalties for failing to file many tax returns; this proposed increase has been kicking around for a while (in fact I wrote about in December a post in PT and had believed it had passed and was signed in to law then). and is now effective for returns required to filed after calendar year 2015. Here’s a little more on the penalty.

As background, Section 6651(a) provides that a taxpayer who fails to file a tax return on or before its due date is subject to a penalty equal to 5 percent of the net amount of tax due for each month that the return is not filed, up to a maximum of 25 that net amount.

Under prior law, the minimum penalty for failure to file certain types of tax returns (including income, estate, and gift tax returns) within 60 days of the due date (including extensions) equaled the lesser of $135 or 100% of the amount of tax required to be shown on the return. H.R. 644 raises the minimum penalty to $205 or 100% of the amount of tax required to be shown on the return, effective for returns required to be filed in calendar years after 2015.

This penalty has a broad reach. In addition to applying to income tax returns of an individual, fiduciary of an estate or trust, or corporation; self-employment tax returns, and estate and gift tax returns), the penalty also applies to returns required to be filed relating to excise taxes on relating to distilled spirits, wines, and beer, tobacco, cigars, cigarettes machine guns and certain other firearms.

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