Industry Director Directive on IRC Section 172(f) Specified Liability Losses
LMSB Control No. LMSB-04-0207-009
Impacted IRM: 4.51.2
April 24, 2007
MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB
DIRECTOR, FIELD SPECIALISTS, LMSB
DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB
DIRECTOR, INTERNATIONAL COMPLIANCE
STRATEGY AND POLICY
FROM: Keith Jones /s/ Keith Jones
Natural Resources and Construction
SUBJECT: LMSB Tier II Issue - Field Directive on the Examination of IRC Section 172(f) Specified Liability Losses #1
This memorandum is intended to provide direction for this LMSB Tier II Issue to effectively utilize resources in the classification and examination of IRC Section 172(f) specified liability loss claims.
Background / Strategic Importance
In early 2005, LMSB and SBSE became aware of an increased number of claims for refund using the provisions of IRC §172(f). The claims were generated as informal claims on examination, formal filings of Form 1120X, Amended U.S. Corporation Income Tax Returns or formal filings of Form 1139, Corporation Application for Tentative Refund. The claims identified to date have been associated with net operating loss reviews conducted by some of the top accounting firms. In the case of specified liability losses incurred for taxable years beginning after December 31, 1990, IRC §172(b)(1)(C) provides an exception to the general carryback period. Under this exception, the normal two-year carryback period is replaced with a 10-year carryback period. As a result, the portion of a net operating loss that qualifies as a specified liability loss may be carried back to each of the 10 taxable years preceding the loss year.
The current version of IRC §172(f) was implemented by the Tax and Trade Relief Extension Act (TTREA) of 1998, P.L. 105-277, §3004(a), and applies to net operating losses arising in tax years ending after October 21, 1998.
The 1998 amendment to IRC §172(f) substantially narrowed the scope of expenditures eligible for the 10-year carryback and now applies to only a limited class of losses. The purpose of this amendment was to lessen the controversy as to the proper interpretation of the specified liability loss provisions by providing a definitive list of eligible items.
Thus, effective for losses incurred in tax years ending after October 21, 1998, specified liability losses are defined to include the following:
Deductible product liability amounts or expenses incurred in investigating or settling a product liability;
Deductible expenses incurred in satisfaction of Federal or State laws in connection with-
a) Reclamation of land,
b) Decommissioning of a nuclear power plant,
c) Dismantlement of a drilling platform,
d) Remediation of environmental contamination, or
e) Payments under a workers compensation act.
The first category of specified liability losses includes certain losses attributable to product liability. See IRC §172(f)(1)(A). This encompasses any amount allowable as a business expense deduction under IRC §162 or a loss deduction under IRC §165 that is attributable to:
Product liability, or
Expenses incurred in investigating, opposing, or settling claims against the taxpayer on account of product liability.
The second category of specified liability losses consists of certain deferred liability losses described in IRC §172(f)(1)(B). Expenditures falling under this provision must meet the following requirements:
The amount is allowable as an income tax deduction for an amount paid in satisfaction of a liability under a federal or state law requiring:
a) The reclamation of land;
b) The decommissioning of a nuclear power plant or any unit thereof;
c) The dismantlement of a drilling platform;
d) The remediation of environmental contamination; or
e) A payment under any workers compensation act within the meaning of §461(h)(2)(C)(i).
The act or failure to act giving rise to the liability occurs at least three years before the beginning of the taxable year;
The taxpayer used the accrual method of accounting throughout the period or periods during which the act or failure to act giving rise to the liability occurred; and
The amount is not allowable as a deduction under §468(a)(1) [election regarding certain mining and solid waste reclamation and closing costs] or §468A [election regarding certain payments made to a Nuclear Decommissioning Reserve Fund].
The nature of the issues identified to date relate to whether or not the claimed expenditures are indeed qualified specified liability losses under §172. This analysis includes:
Whether the incurred costs are allowable deductions, as opposed to capital expenditures, and
Whether or not the costs were incurred in satisfaction of a Federal or State law requiring the expenditure, as opposed to company policy or other mandate and
Whether or not the act or failure to act that gave rise to the liability occurred at least three years prior to the beginning of the taxable year in which the amount is allowable as a deduction, as opposed to a normal current business operating expense.
This issue was designated by NRC as an emerging issue for LMSB and SBSE on June 23, 2005. NRC established an Emerging Issue Team to determine the impact of these claims and develop examination guidance for consistency in issue resolutions.
Any claim cases having this issue should use the Project code 0047 and ERCS Tracking code 7942. The following are the UIL and SAIN codes to be used:
Failure to Substantiate: UIL Code 172.05-00 SAIN 529-01, *Second Tier SAIN 350
Product Liability: UIL Code 172.06-00 SAIN 529-01, *Second Tier SAIN 351
Deferred Statutory or Tort Liability Losses: UIL Code 172.07-00 SAIN 529-01, *Second Tier SAIN 352
*An IRM revision is pending which provides for the use of three digit second tier SAIN numbers for Tier I and Tier II issues.
Planning and Examination Guidance
This issue is considered a Tier II issue for LMSB examiners. This issue is required to be addressed in examinations if present.
Attached are examination guidelines with audit steps to be followed to address allowable expenditures for each type of specified liability loss claims.
Product Liability – see Attachment 1.
Land Reclamation Expenditures – see Attachment 2.
Decommissioning of a Nuclear Power Plant or any Unit thereof – see Attachment 3.
Dismantlement of a Drilling Platform – see Attachment 4.
Remediation of Environmental Contamination – see Attachment 5.
A payment under any workers compensation act within the meaning of §461(h)(2)(C)(i) – see Attachment 6.
It is also recommended that examiners make inquiries as to any insurance reimbursements received associated with the expenditures claimed as a specified liability loss.
Effect on Other Directives
This Directive does not amend or obsolete any other Directive on the subject.
If you have any questions, please contact Jody Botsford, IRC §172(f) Technical Advisor at 626-312-5101 or Jody.N.Botsford@irs.gov , Paula Farmer, Mining Technical Advisor at 281-721-7539 or Paula.J.Farmer@irs.gov . This issue was designated as an emerging issue in Appeals on January 27, 2006. The contact person for Appeals is Joann Huerta, Appeals Technical Guidance Coordinator – Mining, Sports & IRC 172(f) who can be reached at 954-423-7933.
This LMSB Directive is not an official pronouncement of the law and cannot be used, cited, or relied upon as such.
cc: Commissioner, LMSB
Deputy Commissioner, LMSB Operations
Deputy Commissioner, LMSB International
Division Counsel, LMSB
Directors, LMSB Field Operations
Director, LMSB Performance, Quality and Audit Assistance