Tax Procedure: California Should Conform to Federal Law and Allow Expedited Tentative Nol Refunds

• Jurisdiction: California,United States
• Author: By Benjamin Elliott & Lauren Knapp
• Citation: Vol. 26 No. 3
• Publication year: 2017

Tax Procedure: California Should Conform to Federal Law and Allow Expedited Tentative NOL Refunds1

By Benjamin Elliott & Lauren Knapp²

I. EXECUTIVE SUMMARY

California passed legislation in 2010 allowing Net Operating Losses ("NOLs") attributable to taxable years beginning on or after January 1, 2013, to be carried back by taxpayers to the two prior tax years, similar to the Federal rules.³

The NOL carryback rules allow taxpayers to use NOLs sooner than they otherwise would be able to without a carryback provision, thereby providing taxpayers with a refund where they otherwise may need to wait several years to be able to use the NOLs in the future, if ever. Further, while use of NOL carryforwards were suspended in California for most taxpayers⁴ during taxable year beginning on or after January 1, 2011, taxpayers using this new NOL carryback rule are allowed to carryback NOLs from applicable years into 2011 when such taxpayers were not otherwise allowed to use NOL carryovers.

In practice, however, the implementation of the new rules is less than streamlined. The authors of this article propose that the state follow the program implemented by the Internal Revenue Service ("IRS"), which allows taxpayers to apply for an expedited refund for NOL carrybacks. This can be achieved by either adopting similar provisions legislatively or by implementing an administrative program, thereby providing taxpayers access to a tentative refund program in order to expedite the process of obtaining a refund resulting from the use of an NOL carryback.

II. DISCUSSION

A. Current Law and Reason for Proposed Change

California Revenue and Taxation Code ("CRTC") sections 17276.22 and 24416.22 provide that NOLs are allowed to be carried back into the two preceding tax years beginning with NOLs attributable to taxable years beginning on or after January 1, 2013. This is the first time that California has allowed taxpayers to carryback their NOLs.

Mechanically, in order to utilize the NOL carryback in California,⁵ taxpayers must (1) file a FTB Form 3805V for individuals or FTB Form 3805Q for corporations, NOL Computation and NOL and Disaster Loss Limitations, to compute the NOLs, and (2) file an amended return for the year or years to which the NOLs are being carried back.⁶ The amended return will be treated as a claim for refund and handled through the normal refund channels. To streamline the cash benefit, the Franchise Tax Board ("FTB") allows certain taxpayers who are expecting an NOL in the next tax year to request an Extension of Time for Payment of Taxes by a Corporation Expecting a Net Operating Loss Carryback, to extend the date for payment of taxes for the immediately preceding tax year.⁷

Internal Revenue Code ("IRC") section 172(b)(1)(A)(i) provides the Federal rules for NOL carrybacks. The federal rules are essentially identical to the California rules, and served as the model for the California rules. Similar to California's NOL carryback rule, for federal tax purposes, taxpayers may carry back NOLs to the two preceding taxable years.⁸ However, beginning in 1978, the IRS implemented a program allowing taxpayers to apply for tentative refunds resulting from the use of NOL carrybacks under IRC section 6411. Under that program, taxpayers that decide to apply for a tentative refund must file a Federal Form 1139 (Corporation Application for Tentative Refund) for corporations and Federal Form 1045 (Application for Tentative Refund) for individuals. The IRS will process the application within 90 days for administrative errors.⁹ The refund may be disallowed if there are any material omissions or math errors that are not corrected within the 90-day period.¹⁰ If the application is denied in whole or part, no suit challenging the disallowance may be brought in any court, but the corporation can file a regular claim for credit or refund.¹¹ The payment of the tentative refund amount does not mean that the IRS has accepted the application as...