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Thrift NOL carrybacks may be in jeopardy.

The Sixth Circuit Court of Appeals has reversed a Tax Court Memo decision in Peoples Federal Savings and Loan Association of Sidney, 6th Cir., 11/6/91, rev'g TC Memo 1990-129. The Tax Court decision was based on its decision in Pacific First Federal, 94 TC 101 (1990) (which is currently under appeal in the Ninth Circuit). Both Tax Court decisions allowed the carryback of a thrift net operating loss (NOL) without a recomputation of the percentage of taxable income bad debt deduction in the carryback year. This carryback method directly contradicts a regulation, which the Tax Court ruled invalid.

Peoples Federal involves the interaction between the percentage of taxable income bad debt deduction under Sec. 593 and the NOL carryback provisions of Sec. 172, as well as the validity of Regs. Sec. 1.593-6A(b)(5)(vi) and (vii). This regulation provides that taxable income, for purposes of the percentage of taxable income bad debt deduction, will take into account a Sec. 172 NOL deduction. This, in effect, forces a savings and loan to recompute and reduce its bad debt deduction in a previous tax year to which it is carrying back an NOL, significantly increasing the taxable income in the carryback year and absorbing more NOL without any increased tax benefit.

Because the IRS changed the regulation in 1978 without an initiative from Congress, the validity of Regs. Sec. 1.593-6A(b)(5) has been questioned. The previous regulation, promulgated in 1964, specifically provided that taxable income for purposes of Sec. 593 was to be computed without regard to any NOL carrybacks. Before the regulation was issued, the Service had ruled (in Rev. Rul. 58-10) that a subsequently occurring NOL did not change a bad debt deduction that was reasonable at the time it was computed into a unreasonable deduction. When Congress twice reduced the percentage available under Sec. 593 for computing the bad debt deduction (in 1962 and in 1969), it did not mandate any change in the regulations. From at least 1958 through 1978, the IRs held that deductions for additons to loan loss reserves need not be recomputed when NOLs were carried back.

With that in mind, peoples Federal charged that the Service had changed its longstanding position without an official mandate from Congress, and that the original regulation prior to 1978 reflected Congress's true intent. The taxpayer contended that leaving the IRS's old regulation intact, when it easily could have been changed, showed that Congress implicitly approved of it. The Tax Court in Pacific First Federal, and later in its memo decision in Peoples Federal, agreed. The court held that the Service's 1978 change violated congressional intent and was therefore an invalid exercise of the Treasury's rulemaking authority.

In the first appeals decison handed down on this issue, the Sixth Circuit disagreed. The Court of Appeals agreed that the language of Sec. 593 was ambiguous with respect to the computation of taxable income. However, it did not agree with the Tax Court's finding that the intent of Congress had been violated by the Service's change in regulations. The Court of Appeals found that there was no evidence in the legislative history of Sec. 593 that congress ever had specific or particular intent as to the application of NOL carrybacks. In addition, the court said that Congress had never noticed the existence of, and never referred to, either the old or new regulations in question.

Although it is clear that the Service had changed its policy after almost 20 years of maintaining a contrary position, the Court of Appeals stated that it was reasonable and permissible for the IRs to correct what it perceived to be a mistake in the regulations. The court rejected the notion that the Service may not deliberately change a prior interpretation, noting that, in 1978, the Assistant Treasury Secretary for Tax Policy characterized the old regulation as "patently wrong" and found it should be changed.

Consequently, the Court of Appeals found that after decades of Congress's complete silence and inaction regarding these two regulations, it would be reasonable to infer a congressional purpose to leave the interpretation of Sec. 593 in this case the the IRS.

As it stands currently, the fate of this issue rests on the Ninth Circuit. If Pacific First is upheld, an appeal could be filed with the Suprem Court. If, however, the Ninth Circuit reverses the Tax Court, there is little chance the issue will be resolved in favor of the thrift industry.
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Title Annotation:net operating loss
Author:Bryant, W. Michael
Publication:The Tax Adviser
Date:Feb 1, 1992
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