Net Operating Losses
Carrybacks and Carry Forwards

see discussion regarding RSED here

see Form 1045 & 1040X instructions here

see NOL helpful hints here


Net Operating Losses (NOLs) generally can be used to offset other taxable income in prior years and in future years. Individuals need to decide at the time that they timely file their Form 1040 (if it shows a current year NOL) whether they want to elect pursuant to IRC §172(b)(3) to carry forward the loss to offset future taxable income, or to go with the default to carry the loss back two years (or occasionally another allowable period of time) and recoup taxes previously paid, plus occasionally even some interest on the money! (see discussion regarding IRS interest payments here). The odds of an audit are higher when an individual trader’s NOL carry back is filed using Form 1045 (with a proforma Form 1040X as an attachment) and are even higher when filed using only Form 1040X (without using Form 1045). But if all your ducks are in a row, the result is a refund of taxes paid at your potentially higher tax brackets in 2014 (than in 2017, for example) for a loss incurred during 2016.  A taxpayer generally has until October 15, 2017 to make this decision.

As with many regulatory or statutory tax elections, a taxpayer may elect to carry forward the loss by filing the election up to six months after the initial due date of a timely filed return, pursuant to Reg. 301-9100-2(b).  If you filed your original return on time but did not file the statement with it, you can make this choice on an amended return filed within 6 months of the due date of the return (excluding extensions). Attach a statement to your amended return, and write “Filed pursuant to section 301.9100-2” at the top of the statement. Once you choose to waive the carryback period, it generally is irrevocable, except perhaps with a timely filed superseding return. If you choose to waive the carryback period for more than one NOL, you must make a separate choice and attach a separate statement for each NOL year. If you do not file this statement on time, you cannot waive the carryback period.

Optionally a IRC §172(b)(3) election may be filed with a timely filed Form 1040 to carry forward the NOL rather than going back for a refund. The odds of audit when taking this approach are far less because there is no manual handling and examination of a Forms 1045 or 1040X along with your prior year 1040s (this is because Forms 1045 and 1040X are not filed when the taxpayer elects to carry forward). A trader might decide to carry forward if he was in low tax brackets in prior years, or he expects to be in higher tax brackets in future years, or if there are potentially any skeletons in the closet with his prior year returns. Additionally, by going back, the statute of limitations is extended giving the IRS extra time to begin an audit. Some people may see it as making no sense to potentially open a can-of-worms looking for a refund of prior year taxes if the prospects of going forward are more advantageous.

Another detriment of carrying back is that on the way back the taxpayer often forfeits several deductions, credits and exemptions that he originally was entitled to, thereby reducing the net benefit of the deductible NOL  For example: while it is necessary to refigure your income tax, alternative minimum tax, and credits, do not refigure your self-employment tax and additional Medicare tax. For information about refiguring your net investment income tax (NIIT), shared responsibility payment, and credits, see the Instructions for Form 1045 and the Instructions for Form 1040X and the Instructions for Form 8960 and IRS Publication 536.

In summary, when an individual trader’s tax year 2016 M2M losses are large enough to create a NOL he must decide whether to carryback or to carry forward the loss. In either case if the year that the NOL is carried to does not fully use up the NOL amount by offsetting other income, then the remaining unused portion of the NOL is carried forward, to be applied year-by-year.

 




Decision to carry back NOL using IRS Form 1045 or using IRS Form 1040X

Taxpayers  considering refund requests based on the carryback of losses or credits must be aware of the potential different results generated by the filing of an application for a tentative carryback adjustment (tentative) filed on a Form 1045, Application for Tentative Refund (for individuals), or Form 1139, Corporation Application for Tentative Refund (for corporations), versus the filing of an actual claim for refund (claim) on a Form 1040X, Amended U.S. Individual Income Tax Return, or Form 1120X, Amended U.S. Corporation Income Tax Return.

One of the most significant differences involves the IRS’s ability to charge interest on subsequently determined deficiencies. While most taxpayers will not be concerned about potential deficiency interest issues, for certain taxpayers the potential negative ramifications of filing a tentative may be significant.

In general, the tentative is limited to specific items listed in Sec. 6411. These items include net operating loss (NOL) carrybacks, capital loss carrybacks and business credit carrybacks. A carryback of foreign tax credits (FTCs) is not specifically mentioned in Sec. 6411 and must be carried back on a Form 1040X or 1120X.

One critical difference in the filing of a tentative versus a claim is the fact that a tentative is a pre-audit refund while a claim generally results in a post-audit refund.

Both tentative and claim carrybacks extend the period of assessment for the carryback year. One distinction related to this extension, which has not been focused on by many taxpayers, must be addressed. If a Form 1045 or 1139 is filed, the statute of limitations (SOL) for assessment of tax for the year to which the carryback is taken (i.e., the carryback year) is actually extended for an amount equal to the refund. This includes amounts related to the carryback and items unrelated to the carryback, as long as the deficiency does not exceed the refund importantly, interest is not subject to this limitation and may result in the Service assessing an amount in excess of the refund. If a Form 1040X or 1120X is filed, the IRS may assess a deficiency attributable to the carryback item, but not one attributable to items unrelated to the carryback, within the extended period.

Could the use of Form 1040X be considered potentially opening-a-can-of-worms:
However, because the Forms 1040X and 1120X result in a pre-refund review, the Service may offset an unassessed, barred deficiency (including barred interest) in the carryback year against the requested refund.

Example 1: Calendar-year corporation C has an NOL carryback from 1993 to 1990. The SOL for assessment on the 1990 year is closed, except for carryback items. The carryback reduced tax by $1,000,000. Upon examination, it was determined that the carryback from 1993 was correct; however, an additional tax adjustment was discovered in the 1990 year. The tax adjustment is $950,000. Absent SOL considerations, deficiency interest of $262,892 would be due on the $950,000 tax increase for the period from 3/15/91 (the due date of the 1990 return) to 3/15/94 (the due date of the 1993 return), plus additional interest until the actual payment.

Scenario A: C files a tentative carryback claim on Form 1139. C will receive the $1,000,000 refund prior to examination of the Form 1139 by the IRS. As a result of the post-refund audit, C will be assessed tax of $950,000 plus deficiency interest of $262,892 for the period 3/15/91 to 3/15/94. In addition, C will be assessed deficiency interest on the $262,892 from 3/15/94 to the date of payment for both the $950,000 plus the appropriate deficiency interest.

Scenario B: C files the NOL carryback on Form 1120X. Although the SOL for assessment is closed on the 1990 tax year, as a result of the pre-refund audit, the $1,000,000 refund created by the NOL carryback will be offset by the barred deficiency ($950,000 + $50,000 of the deficiency interest). C will receive no refund; however, no additional tax or deficiency interest may be assessed.

Example 2: Calendar-year corporation C has an NOL carryback from 1993 to 1990. The SOL for assessment on the 1990 year is closed, except for carryback items. The carryback reduced tax by $1,000,000. Upon examination, it was determined that the carryback from 1993 was correct; however, an additional tax adjustment was discovered in the 1990 year. The tax adjustment is $2,000,000. Absent SOL considerations, deficiency interest of $553,457 is due on the $2,000,000 tax increase for the period from 3/15/91 (the due date of the 1990 return) to 3/15/94 (the due date of the 1993 return), plus additional interest until the actual payment.

Scenario A: C files a tentative carryback claim on Form 1139. C will receive the $1,000,000 refund prior to examination of the Form 1139 by the Service. As a result of the post-refund audit, C will be assessed tax of $1,000,000 plus deficiency interest of $276,728 for the period 3/15/91 to 3/15/94. In addition, C will be assessed deficiency interest on the $276,728 from 3/15/94 to the date of payment for both the $1,000,000 plus the appropriate deficiency interest. Note that the IRS can assess tax only up to the amount of the $1,000,000 refund rather than the $2,000,000 potential tax deficiency. Deficiency interest may then be assessed on the $1,000,000 tax deficiency.

Scenario B: C files the NOL carryback on Form 1120X. Although the SOL for assessment is closed on the 1990 tax year, as a result of the pre-refund audit, the $1,000,000 refund created by the NOL carryback will be offset by a portion of the barred underpayment equal to the amount of potential refund created by the carryback. C will receive no refund; however, no additional tax or deficiency interest may be assessed.

Although a client filing a carryback may need the refund as quickly as possible, a taxpayer must be sure of the significant distinctions between the filing of the request for tentative allowance on Forms 1045 and 1139 versus the claims for refund on Forms 1040X and 1120X. The potential exposure for additional deficiency interest is particularly significant if a 10-year carryback is involved. This could truly be a trap for the unwary.



Could the use of Form 1045 be considered potentially opening-a-can-of-worms:

Internal Revenue Manual on the differences between using IRS Form 1045 or using IRS Form 1040X

IRM 8.17.4.14
Tentative Allowances and Other Carryback Claims in Notice of Deficiency Statement

8.17.4.14.1  (11-09-2007)
Tentative Allowance When Loss/Unused Credit Year Not in Appeals
  1. A tentative allowance is filed on a Form 1045 (individual) or a Form 1139 (corporation) and is identified by the presence of a TC 295 on the account module.
  2. If a notice of deficiency is being issued and the examination of the unused loss/credit year is not complete, or if it cannot be determined if the unused loss/credit year is under examination, completely ignore the tentative allowance in the notice of deficiency.

    Note:This procedure only applies for tentative allowances resulting from the filing of a Form 1045 or Form 1139. It does not apply to carryback claims that were allowed due to the filing of a Form 1040X or Form 1120X.

  3. Ignoring the tentative allowance means:
    1. Do not use net operating loss and capital loss carrybacks giving rise to the tentative allowance to decrease taxable income or alternative minimum taxable income.
    2. Do not use credit carrybacks to decrease tax liability.
    3. Do not include the increase or decrease in tax attributable to a tentative allowance in “tax as previously adjusted” .
  4. If it can be determined that there is no examination activity on the year giving rise to the tentative allowance, and the statute of limitations has expired on that year, include the tentative allowance in the notice in the amount previously allowed.
    1. Although Appeals adjustments may increase taxable income and tax liability in the allowance year, limit the amount of the tentative allowance to the amount originally allowed on Form 1045 (individual) or Form 1139 (corporation).
    2. Increasing the amount of tentative allowance may result in a duplicate allowance to the taxpayer. Only allow an additional amount when it can be determined that the allowance does not result in duplication.
  5. If it is determined that examination of the year giving rise to the tentative allowance has been completed, include the tentative allowance in the notice. Include the amount determined to be allowable based on the examination adjustments made to the loss/unused credit year.

8.17.4.14.2  (09-27-2013)
Tentative Allowance When Both Carryback and Loss/Unused Credit Year in Appeals
  1. If the notice of deficiency is being issued and both the tentative allowance year and the loss/unused credit year are under consideration in Appeals, include both years in the notice of deficiency.
  2. Adjust the year with the tentative allowance (the carryback year) based on adjustments made to the loss/unused credit year.
  3. If adjustments to the loss/unused credit year do not result in a deficiency, then:
    1. Do not include the loss/unused credit year in the notice letter.
    2. Include the loss/unused credit year on Form 4089 (or if prepared, Form 4089-A and Form 870).
    3. Include the loss year on the Form 5278 with the carryback year.
  4. Follow specific procedures if the adjustments to the loss/unused credit year result in an overassessment. See IRM 8.17.4.16.
  5. Include explanations of adjustments for all adjustments to the loss/unused credit year as well as the carryback year.

8.17.4.14.3  (11-09-2007)
Claim for Credit or Refund When Loss/Unused Credit Year is Not in Appeals
  1. This section discusses cases where a notice of deficiency is being prepared and a claim for credit or refund has been filed to carryback a loss/unused credit to one or more of the years included in the notice of deficiency. The claim is filed on an amended return Form 1040X (individual) or a Form 1120X (corporation).
  2. An amended return is identified by the presence of a TC 291 or 299 on the account module.
  3. If a notice of deficiency is being issued and the examination of the year of the loss/unused credit is not completed or if it cannot be determined if the year is under examination, do not ignore the prior allowance in the notice. Discuss the case with the Appeals Officer since the case may have to be returned to Compliance to examine the loss/unused credit year.
  4. If it can be determined that there is no examination activity on the year giving rise to the carrybacks, and the statute of limitations has expired on that year, include the previously allowed claim amount in the notice.
    1. Although Appeals adjustments may increase taxable income and tax liability in the carryback year, limit the carryback claim to the amount originally allowed on Form 1040X/1120X.
    2. Increasing the amount of a carryback claim may result in a duplicate allowance to the taxpayer. An additional amount should only be allowed when it can be determined that the allowance does not result in duplication.
  5. If it is determined that examination of the loss/unused credit year has been completed, include the carryback claim in the notice. Include the amount determined to be allowable based on the examination adjustments made to the loss/unused credit year.

8.17.4.14.4  (09-27-2013)
Claim for Credit or Refund When Loss/Unused Credit Year Is in Appeals
  1. If the notice of deficiency is being issued and both the carryback claim year and the loss/unused credit year are under consideration in Appeals, include both years in the notice of deficiency.
  2. The year with the carryback claim (the carryback year) should be adjusted based on adjustments made to the loss/unused credit year.
  3. If adjustments to the loss/unused credit year do not result in a deficiency, then see below:
    1. Do not include the loss/unused credit year in the notice letter.
    2. Include the loss/unused credit year on Form 4089 (or if prepared, Form 4089-A and Form 870).
    3. Include the loss year on the Form 5278 with the carryback year.
  4. Include explanations of adjustments in the notice for all adjustments to the loss/unused credit year as well as the carryback year.

 




Some additional IRS Form 1045 issues:

Internal Revenue Code Section 6213(b)(3) Assessments arising out of tentative carryback or refund adjustments

If the Secretary determines that the amount applied, credited, or refunded under section 6411 is in excess of the overassessment attributable to the carryback or the amount described in section 1341(b)(1) with respect to which such amount was applied, credited, or refunded, he may assess without regard to the provisions of paragraph (2) the amount of the excess as a deficiency as if it were due to a mathematical or clerical error appearing on the return.

 

Internal Revenue Regulation Section 301.6213-1(b)(2) Exceptions to restrictions on assessment of deficiencies

301.6213-1(b)(2) Tentative carryback adjustments.

(i) If the district director or the director of the regional service center determines that any amount applied, credited, or refunded undersection 6411(b) with respect to an application for a tentative carryback adjustment is in excess of the overassessment properly attributable to the carryback upon which such application was based, the district director or the director of the regional service center may assess the amount of the excess as a deficiency as if such deficiency were due to a mathematical error appearing on the return. That is, the district director or the director of the regional service center may assess an amount equal to the excess, and such amount may be collected, without regard to the restrictions on assessment and collection imposed by section 6213(a). Thus, the district director or the director of the regional service center may assess such amount without regard to whether the taxpayer has been mailed a prior notice of deficiency. Either before or after assessing such an amount, the district director or the director of the regional service center will notify the taxpayer that such assessment has been or will be made. Such notice will not constitute a notice of deficiency, and the taxpayer may not file a petition with the Tax Court of the United States based on such notice. However, the taxpayer, within the applicable period of limitation, may file a regular claim for credit or refund based on the carryback, if he has not already filed such a claim, and may maintain a suit based on such claim if it is disallowed or if it is not acted upon by the Internal Revenue Service within 6 months from the date the claim was filed.

(ii) The method provided in subdivision (i) of this subparagraph to recover any amount applied, credited, or refunded in respect of an application for a tentative carryback adjustment which should not have been so applied, credited, or refunded is not an exclusive method. Two other methods are available to recover such amount: (a) By way of a deficiency notice under section 6212; or (b) by a suit to recover an erroneous refund under section 7405. Any one or more of the three available methods may be used to recover any amount which was improperly applied, credited, or refunded in respect of an application for a tentative carryback adjustment.


If the IRS reviews the NOL carryback more closely after the Form 1045 tentative refund has been issued, and the IRS determines that too much was refunded to the taxpayer, then the IRS can immediately go to Collections to recover the excess, without going through the normal administrative procedures and sending the taxpayer a 30-day letter or 90-day letter with the right to take it to Appeals, etc..  see:
IRC §6213(b)(3) Assessments arising out of tentative carryback or refund adjustments on Form 1045
IRC §6213(b)(1) Assessments arising out of mathematical or clerical errors
IRC §6213(b)(2) Abatement of assessment of mathematical or clerical errors

But if the IRS reviews the NOL carryback more closely after the Form 1040X refund has been issued, and the IRS determines that too much was refunded to the taxpayer, then the IRS needs to go through the normal administrative procedures including sending the taxpayer a 30-day letter or 90-day letter with the right to take it to Appeals.


Joint Committee on Taxation issues

IRB 4.36.2 Identification of Joint Committee Cases
Joint Committee Refund Review: Twelve Questions to Consider

IRC §6213(b) Tentative adjustments
Any credit or refund allowed or made under section 6411 shall be made without regard to the provisions of subsection (a) of this section. In any such case, if the credit or refund, reduced by any deficiency in such tax thereafter assessed and by deficiencies in any other tax resulting from adjustments reflected in the determination of the credit or refund, is in excess of $2,000,000, there shall be submitted to such committee a report containing the matter specified in subsection (a) at such time after the making of the credit or refund as the Secretary shall determine the correct amount of the tax.


Miscellaneous other provisions pertaining to Form 1045 tentative carryback adjustments.