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November 19, 2020

Among the headline-grabbing elements of the CARES Act is the ability of corporations to carry back net operating losses (NOLs) that were generated in taxable years beginning in 2018, 2019 and 2020 to the five preceding taxable years. This has the potential to generate a federal refund of taxes paid for those tax periods. For companies that are in bankruptcy, the ability to obtain liquidity by carrying back the NOL has added value. However, because the company is in bankruptcy, there are additional considerations regarding the mechanics of an NOL carryback that should be considered based on a taxpayer’s particular situation. This alert highlights some of those considerations. 

Methods of NOL Carryback

In general, there are two ways a corporation can carry back an NOL to obtain a federal tax refund. The first is by filing Form 1139, Corporation Application for Tentative Refund. The second is by filing Form 1120X, Amended U.S. Corporation Income Tax Return. While both approaches carry back an NOL and provide a tax refund, each method has different timing and other considerations.

Corporation Application for Tentative Refund
A Corporation Application for a Tentative Refund can be enticing because the taxpayer typically receives the refund within 90 days of the application. However, currently, the timing may be delayed due to COVID-19-related circumstances. This relatively quick processing time comes with a significant limitation: the deadline to file the Form 1139 is generally 12 months from the end of the year in which the loss was generated. The IRS has provided a six-month extension for NOLs that are generated during a taxable year that began in 2018 and ended on or before June 30, 2019. 

It is important to note that under this federal tax refund request approach, the refund claim may be reviewed by the IRS and the Joint Committee on Taxation (JCT), if applicable, after the issuance of the refund. Therefore, the proceeds from the refund should be viewed as giving rise to a contingent liability or a loan until the government has completed its review process. 

Amended Tax Return
An amended return can be attractive because of the longer time allowed in which to file the request (generally three years from the due date of the return, including extensions). Therefore, a taxpayer may be able to file for a refund through a Form 1120X even if the deadline to file the Form 1139 has passed. Additionally, a refund received under this federal tax refund approach should generally be considered final (as opposed to giving rise to a contingent liability). 

Unlike the quick processing of a refund that is requested on a Form 1139, a refund claimed on an amended return can take significantly longer: it may take approximately three to four months, if it is not subject to JCT review, and even longer if it is subject to JCT review. JCT review, which applies to refunds as a result of an NOL carry back in excess of $5 million, generally requires an additional two to three months.

Impacts of Being in Bankruptcy

When a taxpayer is in bankruptcy, immediate liquidity may be a critical component on everyone’s radar. Therefore, companies that are in bankruptcy are attracted by the benefits of filing a Form 1139. But, the speed of obtaining the liquidity comes with decreased certainty associated compared to the certainty of a refund obtained by filing a Form 1120X.  

Form 1139 Filing in Bankruptcy
As mentioned above, a cash refund that is obtained by filing Form 1139 is the equivalent of a loan as the IRS can review the claim and assert that the refund was improper. In the case of a taxpayer in bankruptcy, the IRS can make such an assertion by filing an administrative claim, although it is possible that they do not file such a claim, for the amount of the refund that the IRS believes is improper. In fact, the IRS has been known to file a contingent administrative claim for the full amount of the refund provided as a result of the Form 1139, only to subsequently reduce the amount of its administrative claim or revoke it entirely upon completing its subsequent review of the Form 1139 and associated refund.  This potential is significant because an administrative claim could, if material, impact whether a bankruptcy plan is approved by the Bankruptcy Court. However, unlike other administrative claims, the IRS’ claim has very lenient filing requirements. So much so, that some courts award a priority status to the IRS’ claim, even if it fails to file one, but later raises the possibility of the excess refund to the Bankruptcy Court directly. As a result, taxpayers in bankruptcy often set aside a cash reserve for the risk that the IRS may raise an administrative claim.  

An additional consideration for a taxpayer in bankruptcy is that a Form 1139 does not constitute a tax return, and therefore does not generally fall under the jurisdiction of the Bankruptcy Court.  Therefore, if a Form 1139 is filed, but the IRS has not acted on such a request, then the Bankruptcy Court can generally not require the IRS to process or complete its review of a Form 1139 within a specified period of time.

Therefore, a taxpayer may have to maintain the cash reserve for an extended period of time, and if in fact, the IRS raises a tentative adverse claim, the Bankruptcy Court may have less ability to curtail the review process, as opposed to its potential ability to accelerate the review of a Form 1120X (as discussed below).

A&M Insight: IRS procedures allow a bankruptcy estate trustee to accelerate the review of its tax return, including a tax return that gave rise to an NOL. If those procedures are followed, it is possible that the IRS may also examine the Form 1139 that claims a refund due to the carryback of the NOL at the same time (although this result is definitely not guaranteed). However, it is equally possible that the IRS will merely assure the taxpayer that it does not owe any tax for the taxable year, without determining the amount or validity of the NOL that is shown on the tax return. 

Form 1120X Filing in Bankruptcy
As mentioned above, Form 1120X typically takes longer to process than a Form 1139. For taxpayers that are in bankruptcy, it is possible to accelerate the processing time to provide needed liquidity (although it will still generally not be as fast from a liquidity standpoint as a Form 1139). In essence, taxpayers accomplish this by satisfying certain procedural requirements, which bring the refund claim under the Bankruptcy Court’s jurisdiction so that the court can, but is not required to, require the IRS to expedite the handling of the Form 1120X. If the IRS fails to act within 120 days of a properly filed Form 1120X, the Bankruptcy Court has the discretion to determine the amount of the refund to which the taxpayer is entitled, and its determination is binding on the IRS. From a practical standpoint, however, if the IRS notifies the Bankruptcy Court that it needs additional time for its review, the Bankruptcy Court will generally grant additional time. Nonetheless, following these procedures typically accelerates the IRS’ review procedures.

A&M Taxand Says

Every situation has its own unique characteristics and circumstances when it comes to a taxpayer that is in bankruptcy.  There are numerous directions the bankruptcy proceedings can take, all with the ultimate goal of procuring as much cash for the estate, when time is of the essence. When determining the best path forward to obtain a federal tax refund while in bankruptcy, there is no one size fits all approach. The A&M Restructuring Tax Services group addresses these and many other bankruptcy-related and Tax attribute preservation issues on a daily basis. If you are in bankruptcy, or considering filing for bankruptcy, we would be happy to assist you or your advisors in navigating these, as well as other relevant, nuances. 

Related Insights

IRS Issues New Non-Binding Guidance on NOL Carrybacks

Yesterday, the IRS released new questions and answers (Q&As) without much fanfare providing information for C corporations that carry back net operating losses to pre-TCJA years in which the alternative minimum tax (AMT) applies.

To Carry Back, or Not to Carry Back, That is the Question

In an effort to provide liquidity to taxpayers, as part of the CARES Act, Congress has enabled taxpayers to carry back a net operating loss (NOL) arising in a taxable year beginning after December 31, 2017, and before January 1, 2021 for five taxable years, and made other changes to the Internal Revenue Code which may allow taxpayers to increase their NOLs for those years.  However, there is no cookie-cutter answer to the question whether taxpayers should take advantage of some of these law changes, including the ability to carry back NOLs.