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Industry Director Directive on IRC Section 172(f) Specified Liability Losses - Attachment 2

Issue Name
Reclamation of Land

Introduction:

Section 172(f) provides special rules for the portion of an NOL that is identified as a specified liability loss (SLL) and as such is allowed a ten year carry back as opposed to the two years generally allowed for NOLs. Section 172(f) was amended in 1998 to restrict the types of expenses that qualify as SLLs and therefore now only applies to a narrow set of liabilities.

IRC §172(f)(1) now requires that, for an amount to qualify as an SLL, it must be "in satisfaction of a liability under a Federal or State law requiring—(I) the reclamation of land, (II) the decommissioning of a nuclear power plant (or any unit thereof), (III) the dismantlement of a drilling platform, (IV) the remediation of environmental contamination, or (V) a payment under any workers compensation act (within the meaning of §461(h)(2)(C)(i)).”

All U.S. mining operations are required to undertake reclamation and have detailed reclamation plans that must be approved by government officials before mining begins.  Reclamation bonds may be required of the mining companies to ensure a successful completion of the process and may have detailed cost information.  Although underground mines may not have as much surface disruption as a surface mine, they do have reclamation requirements for stabilizing tailings (waste), ponds, removing surface facilities and reclaiming disturbed areas when mining is completed.

▲ Caution!

The Surface Mining Control and Reclamation Act of 1977 (SMCRA) is a federal law requiring the reclamation of coal mines in the United States.  This law is only applicable to coal mines.  For non-coal mine or quarry reclamation, individual states will have separate laws for general restoration requirements and or specific restoration requirements which are dependent upon the type of mineral products produced in the state.

Expenditures incurred for the reclamation of land at mining operations qualify as specified liability losses.  IRC §172(f)(1)(B)(i)(I).

Reclamation may include the following activities:

  • dismantlement of surface facilities
  • contouring and grading of land;
  • the placement of subsoil and topsoil or an approved substitute on the graded area;
  • reseeding with native vegetation, crops and/or trees;
  • and future monitoring to assure success.

There are some potential issues regarding reclamation SLLs that examiners need to be aware of and include the following:

  • Issue 1: Qualified reclamation versus current operating or capital expenditures
  • Issue 2: Reclamation deductions claimed under IRC §468 do not qualify as SLLs
  • Issue 3: Reclamation of land disturbed within 3 years of the taxable year
  • Issue 4: When Depreciation may qualify as an SLL


Issue 1: Qualified reclamation versus current operating or capital expenditures

Examiners should be aware that taxpayer claims for reclamation deductions as a qualified specified liability loss subject to IRC §172(f) may include non qualified expenditures for current operating and capital costs. 

Current operating costs to maintain compliance with permits or Federal or State mining laws may not be qualified reclamation or may not meet the 3 year rule pursuant to IRC §172(f)(1)(B)(ii)(I).  For example, costs of extraction of a mineral product from the ground are not reclamation costs to restore land disturbed from the extraction process.  However some concurrent backfilling (with material from the current extraction process) of land disturbed 3 years prior to the taxable year may be qualified reclamation for purposes of IRC §172(f).  Similarly, costs of maintaining permit compliance such as spraying water on roads to minimize dust are not qualified reclamation, even though the roads were built more than 3 years prior to the taxable year and will be subject to removal and reclamation in the future.

Taxpayer claims for reclamation deductions may also include nonqualified capital costs.  For example, current operating permits and reclamation plans may require the construction of sediment or tailings (waste) disposal impoundments.  These impoundments, when filled to capacity, will be required to be sealed, closed and reclaimed.  The construction of these impoundments are capital costs subject to IRC §263(a) and as such are not currently deductible nor subject to IRC §172(f), even though the impoundments themselves will be reclaimed in the future.

Audit Steps

  • Examiners should request a detailed break down of reclamation costs and activities that the taxpayer has claimed as specified liability losses.
    • Reference -  Initial Pro Forma IDR for Issue Development
  • Examiners should also request the taxpayer’s mining and reclamation plans and maps which would be filed with State or Federal authorities as part of the taxpayer’s mining permit application. 
  • Note that the taxpayer will also be required to file annual reclamation activity reports with the State or Federal permitting agency.  Request these annual reports and conduct the following analysis:
    • Reconcile the claimed costs and activities to those listed in the reclamation plan.
    • Identify any potential non-qualifying operating and capital costs.
    • Identify land disturbance dates from the mining plan and compare it with the current reclamation activities.

Issue 2: Reclamation deductions claimed under IRC §468 do not qualify as SLLs

Examiners should be aware that taxpayer deductions for reclamation claimed pursuant to IRC §468 do not qualify as specified liability losses subject to IRC §172(f).

IRC §468 is an elective provision that allows taxpayers to accrue and deduct mine reclamation and solid waste disposal property closing costs in advance of the economic performance rules under IRC §461.

Election to deduct reclamation costs under IRC §468 is mutually exclusive to qualification as a specified liability loss for purposes of the 10 year carry back. IRC §172(f)(1)(B)(i).

Audit Steps

  • Examiners should ascertain whether the taxpayer has an IRC §468 election in place.  There are no treasury regulations for IRC §468 and therefore the specific method of election is not always apparent. 
    • Review the tax return for election statements.
    • Specifically ask the taxpayer if an election has been made in a prior year.  Sometimes taxpayers will simply accrue reclamation for tax purposes which may be considered a deemed election under IRC §468.
    • Although there may be a Schedule M adjustment for reclamation, financial accruals for reclamation will be different from the tax accrual for reclamation due to the interest provisions of IRC §468.  Do not mistake this Schedule M as a reversal of financial accruals.
    • Take issue with any IRC §172(f) claims where a deduction for reclamation has been claimed under IRC §468.

Issue 3: Reclamation of Land Disturbed within 3 years of the taxable year

For purposes of the 10 year carry back, a liability shall be taken into account only if:

  1. The act (or failure to act) giving rise to such liability occurs at least 3 years before the beginning of the taxable year, IRC §172(f)(1)(B)(ii)(I), and
  2. The taxpayer used an accrual method of accounting throughout the period or periods during which such act (or failure to act) occurred, IRC §172(f)(1)(B)(ii)(II).

Nearly all mining operations are governed by either Federal or State laws requiring reclamation of the land subsequent to mining.  All coal mines are governed by the Surface Mining Control and Reclamation Act of 1977, (SMCRA), a Federal law.  Other non coal minerals reclamation will be governed by individual state laws and vary in the degree or amount of reclamation required by state and by mineral type produced within the state.  For example, a sand and gravel quarry may have different reclamation requirements from a phosphate rock mining operation within the same state.  Both the sand and gravel and phosphate mine reclamation may be different from any coal mine reclamation required under federal law.

In many instances, state regulations for reclamation will specifically identify the time period between when the land is disturbed from mineral extraction and when reclamation must begin and when reclamation must be completed.

To qualify as a specified liability loss subject to the 10 year carry back, any qualified reclamation of land must address a reclamation liability that occurred at least 3 years prior to the beginning of the taxable period in which the costs were incurred.  The act of disturbing the land for mineral production is the act that establishes the reclamation liability.

Audit Steps

  • The examiner should identify and understand the Federal or State law that establishes the taxpayer’s reclamation liability.
  • Examiners should also request the taxpayer’s mining and reclamation plans and maps which would be filed with State or Federal authorities as part of the taxpayer’s mining permit application. 
  • Note that the taxpayer will also be required to file annual reclamation activity reports with the State or Federal permitting agency.  Request these annual reports and conduct the following analysis:
    Attachment 2
    • Request copies of the Federal or State laws requiring the extent of reclamation.  These laws can also be accessed using internet research for any particular state.
    • Review the timing requirements for the commencement and completion of reclamation.
    • Ensure that reclamation costs claimed as a qualified specified liability loss meet the 3 year rule by comparing reclamation costs incurred to areas disturbed by mining.  (Use reclamation reports, reclamation maps and mining maps requested to compare costs incurred to areas disturbed and reclaimed.)

When Depreciation may qualify as an SLL

While liabilities arising under federal or state law may constitute a portion of the depreciable basis of an asset, depreciation deductions arising from the liability giving rise to the depreciable basis of a depreciable asset are not included as part of the specified liability loss solely because the source of that portion of the basis arises from a federal or state liability.

Depreciation deductions may be allowable with respect to liabilities (including reclamation) satisfied through the use of the depreciable asset.  For example, depreciation on a bulldozer used to contour or grade land may be included as part of the specified liability loss.

Liabilities arising under federal or state law may be treated as part of the cost basis of property if the liabilities are properly chargeable to a capital account.  For example, IRC §164(a) requires sales taxes imposed on the purchase of equipment used in a taxpayer’s trade or business to be capitalized into the cost basis of the equipment.

If an NOL is incurred for a taxable year and the sales tax liability was incurred at least 3 years before the beginning of that taxable year, some taxpayers have asserted that any portion of the NOL generated by depreciation deductions for the portion of the property’s depreciable basis attributable to the capitalized sales tax constitutes a pre-1998 IRC §172(f)(1)(B) specified liability loss irrespective of how the property is used.  Likewise, taxpayers may be required to place certain equipment into service to comply with requirements of federal or state law, for example, clean water standards.  Some of these taxpayers have asserted that if the equipment was acquired by the taxpayer at least 3 years prior to the beginning of the taxable year, the portion of any NOL generated for the taxable year by depreciation deductions attributable to the equipment qualifies as a former IRS §172(f)(1)(B) specified liability loss.  The Service disagrees with both of these assertions.

IRC §167(a) allows a depreciation deduction only for property that is either used in a trade or business or held for the production of income.  Whether a depreciation deduction is allowable “with respect to” a liability depends upon the property’s actual use.  For example, if a taxpayer uses equipment to satisfy an environmental cleanup liability imposed by federal law, the portion of the equipment’s depreciation allocable to satisfying the environmental cleanup liability is allowable with respect to the environmental cleanup liability.  If the environmental cleanup liability arose as a result of a chemical spill that occurred at least 3 years before the beginning of the taxable year and the environmental cleanup liability is otherwise deductible, the depreciation deductions may generate a specified liability loss.  However, if a taxpayer uses equipment to satisfy environmental cleanup liabilities that arise during the same taxable year the depreciation deductions are allowable, for example, by preventing the discharge of pollutants resulting from manufacturing activities during the current taxable year, the act giving rise to the taxpayer’s environmental cleanup liability will not satisfy the 3-year act or failure to act requirement of former IRC §172(f)(1)(B)(i), irrespective of when the taxpayer placed the cleanup equipment in service.

Reference: IRS Notice 2005-20  

Audit Steps

  • Examiners should review any claims for depreciation as a qualified specified liability loss and ensure that the depreciation is related to capital assets used in satisfying a liability as opposed to a deduction claimed with respect to the liability giving rise to depreciable basis of a depreciable asset.
Page Last Reviewed or Updated: 11-Feb-2014