Debtor's use of NOLs received from bankruptcy estate.

The Tax Court recently ruled that a former debtor in bankruptcy (P) could apply net operating losses (NOLs) acquired from his bankruptcy estate against nonbankruptcy income recognized during the bankruptcy proceeding.

Issues

The IRS contended that P is entitled to carry forward qualified NOLs only to years occurring after the bankruptcy termination; P argued that he can apply bankruptcy estate losses that he succeeded to at confirmation, to any year after bankruptcy commencement. He also contended that he can apply his own prebankruptcy NOLs to his tax years following the bankruptcy commencement, to the extent not used by the bankruptcy estate.

Law

At the commencement of a bankruptcy under Title 11, the estate becomes a taxable entity treated as an individual taxpayer as to the computation of income from the estate's assets. The debtor continues as a separate taxable entity during the bankruptcy, as to income that the bankruptcy estate is not entitled to under Title 11. Under Sec. 1398(g), the estate succeeds to certain of the debtor's income tax attributes, including his or her NOL carryovers under Sec. 172, and capital loss carryovers under Sec. 1212, from tax periods before the commencement of the bankruptcy; see Sec. 1398(g)(1) and (5). To the extent the estate has not used those same tax attributes, the debtor succeeds to them under Sec. 1398(i) when the estate terminates.

Although a debtor may succeed to an estate's NOLs when the estate terminates, Sec. 1398(j)(2)(B) expressly prohibits the debtor from carrying back the estate's or the debtor's post-commencement losses to pre-petition tax years. However, that section prohibits only carrybacks to pre-commencement years; it does not place any limit on post-commencement years. The use of the bankruptcy commencement date in Sec. 1398(j)(2)(B) to demarcate the earliest year to which a loss may be carried back, as well as the earliest year from which such a loss may emanate, favors P's position that he may carry forward NOLs received from the bankruptcy estate to post-commencement years.

Sec. 1398(g)(1) and (i) each provide that a debtor succeeds to loss carryovers under Sec. 172, which allows a deduction for the tax year of "an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year." The allowable carryback and carryforward periods for the tax years at issue are three years and 15 years, respectively, under Sec. 172(b). The amount carried back or over to any tax year is the NOL, to the extent not absorbed in computing the tax (or net income) for other tax years, preceding such tax year, to which it may be carried back or over.

Sec. 172 requires losses to be carried back or forward in a certain order and places limits on the years to which they may be applied. The regimen of Sec. 172 also provides that the year from which the loss emanates does not change. Thus, losses acquired by an estate, or acquired or reacquired by the debtor, are time limited, depending on the source year of the loss. Accordingly, Secs. 1398 and 172 do not circumscribe P's ability to carry, forward pre-petition NOLs that he succeeded to from the bankruptcy estate. Thus, he can use these losses and losses incurred by the bankruptcy estate, to the extent permitted in Sec. 172, in his tax years beginning with the year in which the bankruptcy commenced.

OREN L. BENTON, 122TC No. 20 (2004)