Is Election to Waive NOL Carryback Irrevocable?

You have to be careful when electing to waive the right to carry back a net operating loss. This is particularly true if there are items on your tax returns from earlier years that the IRS may eventually adjust if audited. The Bea v. Commissioner, No. 18-10511 (11th Cir. 2019), case provides an example of this.

Facts & Procedural History

The taxpayers hold their investments in a LLC. The LLC is taxed as a partnership for Federal income tax purposes. The LLC incurred an $11 million dollar loss in 2014.

As a partnership, the $11 million flowed thru and was reported on the taxpayers’ individual income tax return. The taxpayers income tax return reported the $11 million dollar loss, but also included an election to waive the carryback period.

The IRS then audited the taxpayers individual income tax returns and, in 2017, it made adjustments to the taxpayers’ 2012 tax return.

The taxpayers sought to have their $11 million loss carryback to 2012 to offset the IRS’s adjustments. The IRS refused to allow the carryback, as did the U.S. Tax Court. That brings us to this appeal.

Net Operating Loss Carrybacks

A net operating loss arises in any year in which the taxpayer’s business expenses exceed the business income. The net operating loss (“NOL”) then offsets other income the taxpayer recognized in the same year and, absent an election to waive the NOL carryback, it is used to offset income from prior years.

More specifically, unless an exception applies, the NOL for a tax year is carried back to the prior two tax years and is a deduction for each of those two years. Any remaining NOL is carried forward to years after the year of the NOL and is a deduction for each of those later years.

Congress has changed the carryback periods over time. For certain losses, the carryback period was longer. But suffice it to say that the NOL carryback period is generally three years from the year that gave rise to the NOL. And beginning in 2018, as part of the Tax Cuts & Jobs Act, Congress has eliminated the carryback.

Prior to this change, some taxpayers prefer to file an election to waive the carryback period. This was often helpful if the taxpayer was expecting a larger current year tax and did not want to have to come out of pocket to pay the tax.

Is a NOL Carryback Election Irrevocable?

Just because a taxpayer includes a form with its tax return to elect to waive the NOL carryback period, is the election irrevocable? What if the taxpayer did not know of or understand the implications of filing the election?

In this case, the taxpayers argued that the election was included as a form with their tax return. It was presented to them by their tax return preparer in the stack of forms that make up their tax return. Allegedly the taxpayers did not even know the form was included in the return they filed.

The Code says that: “Such election, once made for any taxable year, shall be irrevocable for such taxable year.” But does this limit apply when the taxpayer did not knowingly make the election?

The court’s reasoning is summarized as follows:

Though it was the error of the Beas’ return preparer that put the Beas in this undesirable tax position, the Beas may not now disavow the unambiguous language of the irrevocable election they made on their signed 2014 tax return. The Tax Court correctly interpreted § 172(b)(3) and found that nothing in the statute requires the IRS or courts to consider a taxpayer’s subjective intent in making the election. The Tax Court also found that the Beas did not make an ambiguous election under that section, and therefore the court correctly determined that the Beas could not revoke or disavow their election.

Thus, the election was binding.

It should be noted that even the IRS’s power to grant 9100 relief cannot undo a valid election to waive the NOL carryback. The IRS is not authorized to do so given the express language in the Code.

It should also be noted that this issue is one that the IRS computers are set up to track. Had the taxpayers filed amended returns to report the NOL carrybacks for prior years, these changes will generally trigger IRS notices disallowing the carryback in cases like this. It is then up to the taxpayer to show that the original election was defective.

Given this case, we know that an election is not defective just because the taxpayer did not understand or appreciate the significance of the election he made.