Bankruptcy professional fees are not SLLs for carryback purposes.

• Author: O'Driscoll, David
• Position: Specified liability losses

B, a retail store, filed for Chapter 11 bankruptcy Under the supervision of the bankruptcy court, it employed various legal, accounting and other professionals who incurred fees and expenses. The bankruptcy court eventually entered awards of final compensation to the professionals.

On its 1993 and 1994 Federal returns, B deducted some of the professional fees and expenses resulting from the bankruptcy and capitalized the remaining $5,429,186. In 1998, it filed Form 1120X (claim) for the 1997 tax year, claiming the capitalized bankruptcy costs as a "specified liability loss" (SLL), carrying them back to the 1987 tax year under Sec. 172. B sought a $2,497,426 refund for that tax year.

Analysis

The issue is whether B's capitalized bankruptcy costs were SLLs under Sec. 172(f)(1)(B) and, thus, eligible for the special 10 year carryback period. During the relevant period, Sec. 172(f) defined SLL as follows:

(1) In general.--The term "specified liability loss" means the sum of the following amounts to the extent taken into account ha computing the net operating loss for the taxable year....

(B) Any amount ... allowable as a deduction under this chapter with respect to a liability which arises under a Federal or State law, or out of any tort of the taxpayer if (i) In the case of a liability arising out of a Federal or State law, the act (or failure to act) giving rise to such liability occurs at least 3 years before the beginning of the taxable year.

To apply, there must have been an act which gave rise to a liability under state or Federal law, and the act must have occurred more than three years before the tax year in question.

The IRS has not issued regulations under Sec. 172(f), and there is no relevant legislative history. Additionally, whether the cost of hiring outside professionals during a bankruptcy proceeding is a liability arising under a Federal law has not yet been determined by any appellate court. However, several decisions provide guidance for the analysis.

In Sealy Corp., 171 F3d 655 (9th Cir. 1999), the Ninth Circuit held that fees paid to CPAs to publish reports on employee benefit plans (as required by the Employee Retirement Income Security Act of 1974) and those paid to lawyers mad accountants (to comply with an IRS audit) did not arise under a Federal law. The Ninth Circuit explained, "[i]t is ... not simply an expense incurred with respect to an obligation under Federal law [that meets the statutory definition of a...