Thrift NOL carrybacks may be in jeopardy.

• Author: Bryant, W. Michael
• Position: Net operating loss

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...