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10-year carryback for certain NOLs.

Sec. 172 (f) provides a 10-year carryback period for "specified liability losses." To the extent it does not exceed the net operating loss (NOL) for the year, a "specified liability loss" consists of:

[] Deductions allowable under Sec. 162 or 165 attributable to product liability, or expenses incurred in the investigation or settlement of, or opposition to, claims against the taxpayer on account of product liability; and

[] Any other Federal income tax deduction with respect to a liability that arises

-- under a Federal or state law (e.g., environmental cleanup or workmen's compensation) in connection with an act (or failure to act) that occurred at least three years before the beginning of the tax year, or

-- out of any tort (e.g., patent infringement) of the taxpayer in connection with a series of actions (or failures to act) over an extended period of time a substantial portion of which occurs at least three years before the beginning of the tax year.

Letter Ruling 9441020 may suggest a broader scope of application for Sec. 172 (f) than most practitioners previously envisioned. In addition to the costs of litigating product liability claims, and the costs of other liabilities arising under Federal or state laws for matters occurring at least three years before the tax year, the riding held that specified liability losses included:

1. allowable deductions for interest expense resulting from Federal tax deficiencies relating to tax years at least three years prior to the tax year; and

2. assessments of state tax and related interest expense attributable to tax years at least three years prior to the tax year.

Example: ABC Company has an NOL of $50,000 in 1994. During 1994, the IRS examined ABC's 1990 Federal income tax return. ABC also underwent a state sales tax examination for 1990. The examinations concluded in 1994, with ABC paying $10,000 in additional Federal income tax for 1990, and $9,000 in interest on the deficiency. It also paid $25,000 in state sales tax, including interest.

Per the rationale of Letter Ruling 9441020, ABC must carry $34,000 ($9,000 $25,000) of its $50,000 NOL back to 1984.

This ruling suggests that practitioners may want to review their clients' NOLs with a more expansive view of what costs might fall within Sec. 172(f)'s 10-year carryback provisions.

If an item constitutes a specified liability loss, the 10-year carryback period is the one that applies unless the taxpayer affirmatively elects to forgo it. Accordingly, the Service could challenge the application to the third preceding year (or subsequent years) of an amount that should have been carried back to the tenth preceding year.

Thus, a taxpayer with expenses relating to these items in a loss year will want to carry them back 10 years, or, on a timely filed return, affirmatively elect not to. The 10-year carryback can result in the recapture of taxes paid at much higher rates than currently apply to taxable income.
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Title Annotation:net operating losses
Author:O'Connor, Eileen J.
Publication:The Tax Adviser
Date:Feb 1, 1996
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