Eleventh Circuit: Waiver of NOL Carryback Was Irrevocable

(Parker Tax Publishing February 2019)

The Eleventh Circuit affirmed a Tax Court decision holding that a married couple was not permitted to carry back a net operating loss (NOL) after electing under Code Sec. 172(b)(3) to waive the right to carry back the NOL. The Eleventh Circuit rejected the taxpayers' argument that their paid tax return preparer made the election without their knowledge and that they did not know or understand its implications, finding that when a taxpayer complies with the statutory requirements to make a valid election to relinquish the right to carry back an NOL, the taxpayer is bound by that decision, and nothing in the statute requires the IRS or courts to consider a taxpayer's subjective intent in making the election. Bea v. Comm'r, 2019 PTC 45 (11th Cir. 2019).

Background

Javon and Vita Bea filed joint tax returns for 2011 - 2014. The Beas employed Jo Ann Schoen, an enrolled agent, to prepare their individual and business income tax returns beginning in 1987. Throughout 2011 - 2014, Schoen worked for the firm Accounting & Tax Associates, Inc. and she also prepared the Beas' tax returns for these years.

The Beas own Oronoco Investments, LLC (Oronoco), an investment company organized as a partnership. In 2013, Schoen prepared a Form 1065, U.S. Return of Partnership Income, for Oronoco. The form reflected a net operating loss (NOL) which produced passthrough losses for the Beas (2013 NOL). Schoen later revised the Form 1065 to reflect a reduced amount of loss attributed to the Beas on their respective Schedules K-1, Partner's Share of Income, Deductions, Credits, etc. However, when Schoen prepared the Beas' Form 1040 for 2013, she did not correctly update the Oronoco passthrough losses as reflected in the Schedules K-1. Schoen's failure to make this update resulted in an overstated NOL of approximately $4.9 million on the Beas' 2013 income tax return. The Beas carried this 2013 NOL back to obtain refunds for 2011 and 2012.

In 2014, Oronoco's Form 1065 reflected an NOL of approximately $11.9 million (2014 NOL), which Schoen validly claimed on the Beas' 2014 Form 1040. Schoen elected to waive the entire carryback period with respect to the 2014 NOL - allegedly without consulting the Beas - because she believed the 2013 NOL carryback sufficiently eliminated the Beas' tax liabilities for 2011 and 2012. The Beas signed and filed their 2014 Form 1040.

The IRS audited the Beas' 2011 - 2014 returns, discovered errors in their 2013 return, and in 2017 issued a notice of deficiency that included deficiencies for 2011 and 2012. In response, the Beas sought to carry back their 2014 NOL to apply against their 2012 deficiency, but the IRS refused because the Beas had waived their ability to carry back the 2014 NOL by including the irrevocable election in their 2014 tax return.

The Beas challenged the IRS's actions in the Tax Court. The Beas and the IRS both filed motions for summary judgment. The Beas included with their motion "Additional Material Facts" concerning their ignorance of the election to waive the carryback period. The Tax Court found that the "Additional Material Facts" were irrelevant and entered summary judgment for the IRS, holding that the Beas owed approximately $685,000 for a deficiency in their 2012 income taxes. The Beas appealed to the Eleventh Circuit.

Analysis

In general, for tax years ending before 2018, taxpayers may deduct the sum of (1) NOL carryovers and (2) NOL carrybacks to a tax year on their income tax return for that year. Under the pre-2018 rules, an unused NOL can be carried back to the two years immediately preceding the year recognizing the NOL, then carried forward through the twenty years following the year the NOL was recognized. An unused NOL was required to be carried back two years before being carried forward unless the taxpayer elected under Code Sec. 172(b)(3) to waive his or her right to carry back the NOL. Reg. Sec. 301.9100-12T(d) provides that the election is made by attaching a statement to the return for the year in question stating that the election is made under Code Sec. 172(b)(3) and providing information about the election, including the period for which it applies and the taxpayer's basis or entitlement for making the election. Once made, the election is irrevocable. The Tax Court has held that, when a taxpayer complies with the statutory requirements to make a valid election to relinquish the right to carry back an NOL, the taxpayer unequivocally communicates the election and binds himself or herself to the decision concerning the best use of the NOL.

Observation: As a result of the Tax Cuts and Jobs Act of 2017, carrybacks of NOLs are generally not allowed for NOLs incurred in tax years ending after December 31, 2017. However, taxpayers are allowed to carryback farming losses and losses from an insurance company other than a life insurance company. The carryback period for these losses is two years.

The Beas acknowledged that they took all of the required steps to make a valid Code Sec. 172(b)(3) election. However, they contended that they neither knew nor understood the implications of the election on their 2014 tax return. They also argued that the Tax Court erred in finding irrelevant the "Additional Material Facts" included with their motion for summary judgment. The Beas stated in their motion that the primary issue before the Tax Court was whether their ignorance regarding the Code Sec. 172(b)(3) election permitted them to disavow or revoke the election, and their "Additional Material Facts" were relevant to this issue.

The Eleventh Circuit affirmed the Tax Court's decision to grant summary judgment for the IRS. The court found that the Beas paid Schoen to prepare their tax returns in 2014, and Schoen took all the required steps to make a valid Code Sec. 172(b)(3) election on the Beas' tax return, a point that the Beas did not deny. The court noted that the Beas affirmed with their signatures that they had examined their tax return and subsequently filed the return containing this unambiguous election - which is expressly described as irrevocable by statute. While the Beas said that they did not understand the implications of the Code Sec. 172(b)(3) election, the court observed that they did not ask Schoen about the election on the return that they signed.

The court found that, though it was Schoen's error that put the Beas in this undesirable tax position, the Beas could not now disavow the unambiguous language of the irrevocable election they made on their signed return. The Eleventh Circuit found that the Tax Court correctly interpreted Code Sec. 172(b)(3) and determined that nothing in the statute required the IRS or courts consider a taxpayer's subjective intent making the election. The Eleventh Circuit agreed with the Tax Court that the Beas did not make an ambiguous election, and found that the Tax Court therefore correctly determined that the Beas could not revoke or disavow their election.

The Eleventh Circuit also found that the Tax Court correctly determined that the Beas' "Additional Material Facts" were irrelevant. The Eleventh Circuit agreed with the Tax Court that the Beas' knowledge of the Code Sec. 172(b)(3) election was irrelevant to whether they could revoke it because their signed 2014 tax return contained an explicit, irrevocable election, and there was nothing in the statute or regulations to suggest that taxpayer knowledge might affect the revocability of the election. Thus, the Tax Court did not view further evidence of the Beas' lack of knowledge to be relevant to this inquiry and held the Tax Court did not clearly err in this finding.

For a discussion of determining the carryback and carryforward years of an NOL, see Parker Tax ¶99,110.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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