Statute of limitation for tax carryovers.

• Author: Holets, David J.

It is not unusual for a taxpayer to make an error on a return that results in a misstatement of a net operating loss (NOL) or a credit that is then carried forward. In some cases, these mistakes might not be noticed until after the statute of limitation for the tax year generating the NOL or credit carryover is closed.

Example: W, a C corporation, generated a $10 million NOL and a $1 million Sec. 41 research credit carryover in 2010. W could not carry back either amount. Each year from 2011 through 2014, W had taxable income. In 2015, W expects to use the allowable portions of its 2010 NOL and research credit carryovers. When preparing its 2015 tax return, W discovers the 2010 NOL carryover had been understated by $1 million and the research credit carryover had been understated by $500,000. The statute of limitation for 2010 is closed. Does IE have any options to adjust the carryover amounts from 2010?

Statute of Limitation: NOL Carryover

The statute of limitation to assess income tax under Sec. 6501 is three years after the date a tax return is filed. The statute of limitation for filing a claim for refund under Sec. 6511 is the later of three years from the date a tax return is filed or two years from the date the tax is paid. Sec. 6511(d)(2) further prescribes that in the case of an NOL or capital loss carryback, the statute of limitation to claim a refund is three years from the fifing date of the return that originates the carryback claim.

The statutes do not, however, address what statute of limitation applies to carryover items. Although the answer initially might seem straightforward, case law and IRS guidance yield a different answer from what might be expected.

One of the earlier cases to address how the statute of limitation applies in a similar situation, adjustment of a carryback NOL involving a closed tax year, is Phoenix Coal Co., 231 F.2d 420 (2d Cir. 1956). In Phoenix Coal, the taxpayer had NOLs in 1947 and 1948. The taxpayer timely filed NOL carryback amended returns to use the losses in 1945 and 1946. The NOLs eliminated all of the taxpayer's income in 1945 but only part of its income in 1946.

After the statute of limitation for 1945 closed but before the statute of limitation for 1946 closed, the IRS recomputed the taxpayer's income for 1945. This recomputation did not result in any additional tax assessment for 1945, but it reduced the NOL carryback available for 1946. The court allowed the IRS to reduce the NOL...