The 10-year carryback of SLLs.

• Author: Arber, Stephen C.
• Position: Specified liability losses

Under the general net operating loss (NOL) rules, for tax years beginning after Aug. 5, 1997, NOLs can be carried back by a corporation to the two years immediately preceding the year the loss was sustained. (For tax years beginning before Aug. 6, 1997, the carryback period is three years.)

Under certain circumstances, Sec. 172(f) provides a unique opportunity for taxpayers to recover tax refunds through the carryback up to 10 years of certain NOLs. Recent law changes have significantly limited the use of the special carryback period.

First, Sec. 172(f) only applies to taxpayers using the accrual method, both at the time the loss is sustained and for the carryback year.

Pre-Oct. 22, 1998 Losses

Effective for tax years ending before Oct. 22, 1998, expenses falling in one of the following specified categories are not limited by the general rule, but are permitted a special 10-year carryback period:

1. Amounts attributable to product liability;

2. Amounts attributable to a liability that arises under Federal or state law; or

3. Amounts attributable to a liability that arises out of a taxpayer's tort.

   Expenses within these categories are specified liability losses (SLLs) and are granted the more favorable carryback treatment. (The normal 20-year and 15-year carryforward rules continue to apply to SLLs.)

   For torts or liabilities arising under Federal or state law, to qualify for the special 10-year carryback exception, the act (or failure to act) giving rise to the liability must have occurred at least three years before the year the expense was actually accrued for tax purposes (Sec. 172(f)(1)(B)).

   Taxpayers have attempted to apply Sec. 172(f) to a broad range of deductions. The result was Notice 97-36; the IRS addressed a situation in which a taxpayer had improperly characterized ordinary expenses as an SLL to meet the three-year act requirement and obtain the benefit of Sec. 172(f). The taxpayer had carried back auditing fees incurred to comply with Federal securities law requirements.

   It argued that the company's initial public offering (IPO) date triggered the need for an independent certified annual financial statement to meet Federal securities law. Because the IPO occurred more than three years before the expense year, the taxpayer argued it was entitled to the beneficial treatment.

   According to the notice, such a tenuous link between the "act (or failure to act) giving rise to the expense" and the liability (the independent auditor's fees)...