New developments: short-period losses, tax accrual workpapers and more. (Federal Tax).

Rev. Proc. 2003-34, IRB 2003-18, May 5, 2003, provides new liberalized carryback rules for short-period losses.

Background: Rev. Proc. 2002-37 provides the exclusive procedures for certain corporations to obtain automatic approval to change their tax years. Rev. Proc. 2002-39 provides the general procedures to obtain IRS consent to adopt, change or retain a tax year where the taxpayer does not qualify for automatic approval.

Sec. 6.08 of Rev. Proc. 2002-37 provided, as a term and condition for automatic approval, that a corporation generally cannot carry back a short-period net operating loss (NOL) or capital loss (CL)--the "Original Carryhack Term and Condition."

However, this term and condition was not imposed if the NOL or CL was either $50,000 or less or resulted from a short period of nine months or longer and was less than the NOL or CL for the 12-month period beginning with the first day of the short period.

Sec. 5.04(6) of Rev. Proc. 2002-39 also imposed this Original Carryback Term and Condition for prior IRS approval of tax year changes.

Modified Canyback Term and Condition: The IRS determined that the purpose of the Original Carryback Term and Condition would not be frustrated if the exception to that term were expanded to include short periods of less than nine months, provided that the short-period NOL or CL were less than the NOL or CL for the 12-month period beginning with the short period's first day.

Therefore, Rev. Proc. 2003-34 modifies Rev. Proc. 2002-37, Sec. 6.08, and Rev. Proc. 2002-39, Sec. 5.04(6), so that a short-period NOL or CL must be carried back if it is either (a) $50,000 or less; or (b) less than the NOL or CL (respectively) generated for the full 12month period beginning with the short period's first day. However, the taxpayer must wait for this 12-month period to expire to determine eligibility for Modified Term and Condition (b).

Of course, a taxpayer that can carry back an NOL, but does not wish to do so, must make a timely election to waive the entire carryback period under IRC Sec. 172(b)(3)--or have in place an election under Regs. Sec .1.1502-21(b)(3)(ii)(B) regarding waiver of carryback of NOLs attributable to a consolidated group member acquired from another consolidated group.

Other Rules: Rev. Proc. 2003-34, Sec. 5, contains optional terms and conditions for taxpayers with prior accounting period changes. Sec. 6 sets forth procedures for electing Sec. 5's optional terms and conditions. Effective dates and a transitional rule are provided in Sec. 8.

New IRS Policy on Obtaining Tax Accrual Workpapers

IRS Chief Counsel Notice CC-2003-012, 12, April 9, 2003, enunciates new procedures to be used under the IRS' policy regarding requests for tax accrual and other financial audit workpapers relating to the tax reserve for deferred tax liabilities, and to footnotes disclosing contingent tax liabilities appearing on audited financial statements. This notice also modifies existing procedures for requests for audit and tax accrual workpapers that are not affected by IRS Announcement 2002-63.

Under Announcement 2002-63, the IRS may request tax accrual workpapers in examining any return filed after June 30, 2002, that claims any tax benefit from a transaction that the IRS has determined, at the time of the request, to be a "listed transaction" under Regs. Sec. 1.6011-4(b)--which reads as follows:

"A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service has determined to be a tax avoidance transaction and identified by notice, regulation or other form of published guidance as a listed transaction."

Continued Crackdown on Abusive Welfare Benefit Funds

Background: IRS Notice 95-34 pointed out some significant tax problems associated with certain trust arrangements qualifying as multiple-employer welfare benefit funds that would be exempt from the Secs. 419 and 419A limits. One of these problems was the abuse, by promoters, of the exemption for a plan of 10 or more employers provided by Sec. 419A(f)(6). [See the Aug. 1995 Monthly Statement, Page 7.]

New Attack: IRS Notice 2003-24, IRB 2003-18, May 5, 2003, shuts down a new tax shelter that exploits the exemption from the Sec. 419 and 419(A) limits for a collectively bargained plan under Sec. 419A(f)(5)(A).

The arrangements targeted by Notice 2003-24 are set up through sham labor negotiations to take advantage of Sec. 419A(f)(5)(A). This statutory provision allows deductions for contributions made to welfare benefit funds set up through good faith bargaining by labor unions legitimately representing their members' interests.

The IRS will not allow deductions under this provision if the welfare benefit fund is not set up as a result of good faith bargaining. This may occur where the company's owner purports to bargain on behalf of employees, but the arrangement actually benefits the owner with little benefit for other employees, or in other cases where the facts indicate a lack of good faith bargaining for non-owner employees.

In addition, Notice 2003-24 indicates that certain types of these arrangements are now "listed transactions" for tax reporting purposes.

Stuart R. Josephs, CPA, has a San Diego-based Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation, can be reached at [phone] or [e-mail].