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Industry Director Directive on IRC Section 172(f) Specified Liability Losses - Attachment 6

Issue Name
Payments under a Workers Compensation Act

Introduction:

IRC §172(f) was modified by §3004(a) of the Tax and Trade Relief Extension Act of 1998 (TTREA).  Other than product liability losses, only items specifically enumerated will qualify as Specified Liability Losses (SLL’s) for net operating losses arising in tax years ending after October 21, 1998.  The statute retained the 3-year rule and the requirement for using an accrual method of accounting.

IRC §172(f)(1) now requires that an amount 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)).”

IRC §461(h)(2)(C)(i) references the following:
IRC §461(h) Certain Liabilities Not Incurred Before Economic Performance.–
(1) In general.--For purposes of this title, in determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.
(2) Time when economic performance occurs.--Except as provided in regulations prescribed by the Secretary, the time when economic performance occurs shall be determined under the following principles:
. . .

(C) Workers compensation and tort liabilities of the taxpayer.--If the liability of the taxpayer requires a payment to another person and --
(i) arises under any workers compensation act, or
(ii) arises out of any tort, economic performance occurs as the payments to such person are made. Subparagraphs (A) and (B) shall not apply to any liability described in the preceding sentence.

Audit experience with this tax law area has identified some potential issues that examiners need to be aware of and include the following:

  • Issue 1: Black Lung Federal Excise Tax Payments do not qualify.
  • Issue 2: Insurance premiums do not qualify.
  • Issue 3: Self-insurance must meet the accrual and 3-year rules.

Issue 1: Black Lung Federal Excise Tax Payments do not qualify.

Examiners should be aware that taxpayer’s claims for workers compensation payment expenditures qualifying for the IRC §172(f) SLL 10 year carry-back tax treatment may include non-qualifying payments to the Black Lung Disability Trust Fund.

The Federal Coal Mine Health and Safety Act of 1969, 83 Stat. 792, recognized for the first time in Federal legislation the inadequacy of compensation to miners totally disabled by pneumoconiosis (black lung) and to the miners’ families.  The Act, as amended by the Black Lung Benefits Revenue Act of 1977, Pub. L. No. 95-227, provides two separate and distinct programs in dividing the financial responsibility between the Federal government and the coal industry.  Under this two-part structure, the Federal government assumed the cost of the backlog of claims that had accumulated over decades, while the industry assumed the burden of paying new claims.   Black lung disease is caused by inhaling coal dust for prolonged periods of time, usually at least 10 years.

IRC §4121 imposes an excise tax on domestically produced coal. The taxes collected on the sales of coal are deposited to the Black Lung Disability Trust Fund to finance payments of black lung benefits to afflicted miners.  Producers of coal in the United States are liable for the tax upon the first sale or use of the coal.  Using a Federal Tax Deposit form, the taxpayer should make semi-monthly deposits based on the incurred liability.  In addition, excise taxes are reported on the quarterly filed Form 720 (Quarterly Federal Excise Tax Return).

Some taxpayers have tried to make the nexus that their excise tax payments into this fund are in the nature of a workers compensation benefit.  However, the Service’s position is that these required payments are excise taxes; thus not qualifying for SLL tax treatment.  See Notice 2005-20.

Audit Steps

  • Examiners should request a detailed explanation from the Taxpayer as to the make-up of any workers compensation payments on IRC §172(f) SLL claims.
  • Examiners should also ask if any of the payments claimed as a qualifying SLL expenditure were made to the Black Lung Disability Trust Fund and/or filed on the quarterly filed Form 720 (Quarterly Federal Excise Tax Return).
  • Examiners should ascertain from the Taxpayer the Federal or State law which required such workers compensation payments for any of the claimed SLL expenditures.
  • Ensure that the Taxpayer is using the accrual method of accounting per IRC §172(f)(1)(B)(ii)(II) and that the 3 year rule under IRC §172(f)(1)(B)(ii)(I) is met.

Issue 2: Insurance premiums do not qualify.

Examiners should be aware that some taxpayers have also included their payments for health insurance premiums as qualifying for IRC §172(f) SLL tax treatment under “worker’s compensation”.   These would not qualify for SLL treatment because of the IRC §172(f)(1)(B)(i) requirement that any amount allowable as a deduction must be made in satisfaction of a liability under a Federal or State law.   Health insurance by an employer for the employees is not mandated by a federal or state law.  

Audit Steps

  • Examiners should request a detailed explanation from the Taxpayer as to the make-up of any worker’s compensation payments on IRC §172(f) SLL claims.
  • Examiners should ascertain from the Taxpayer the Federal or State law which required such worker’s compensation payments for any of the claimed SLL expenditures.
  • Ensure that the Taxpayer is using the accrual method of accounting per IRC §172(f)(1)(B)(ii)(II) and that the 3 year rule under IRC §172(f)(1)(B)(ii)(I) is met.

Issue 3: Self-insurance must meet the accrual and the 3 year rules.

Situations may occur when the self-insured employer decides to pay individual employees’ cost from sustained job-related injuries.  In other situations, the self-insured employer may have coverage up to a certain limit and will incur a qualifying expenditure only when they have to make payments in excess of their coverage limit on specific incidents.  Both of these situations are common occurrences for self-insured employers. 

Audit Steps

  • Examiners should request a detailed explanation from the Taxpayer as to the make-up of any workers compensation payments on IRC §172(f) SLL claims.
  • The examiner should make sure that the Taxpayer is using the accrual method of accounting per IRC §172(f)(1)(B)(ii)(II) and that the 3 year rule under IRC §172(f)(1)(B)(ii)(I) is met.

▲ Caution!

Section 1.263A-1(e)(3)(ii)(D)
The regulation excerpt below indicates that workers compensation payments for production workers are required to be capitalized.  Since capitalized workers compensation payments for production workers are not amounts allowable as a deduction under Section 162 or Section 165, they are not eligible for the specified liability loss ten year carryback provisions under IRC §172(f). 

Since it is likely that a significant portion of a manufacturer’s workers compensation payments would relate to production workers, agents should look closely at this area.

Sec.  1.263A-1 Uniform capitalization of costs…….……
(e) Types of costs subject to capitalization--(1) In general. Taxpayers subject to section 263A must capitalize all direct costs and certain indirect costs properly allocable to property produced or property acquired for resale. This paragraph (e) describes the types of costs subject to section 263A.
 …………… 
(3) Indirect costs--(i) In general. Indirect costs are defined as all costs other than direct material costs and direct labor costs (in the case of property produced) or acquisition costs (in the case of property acquired for resale). Taxpayers subject to section 263A must capitalize all indirect costs properly allocable to property produced or property acquired for resale. Indirect costs are properly allocable to property produced or property acquired for resale when the costs directly benefit or are incurred by reason of the performance of production or resale activities. Indirect costs may be allocable to both production and resale activities, as well as to other activities that are not subject to section 263A. Taxpayers subject to section 263A must make a reasonable allocation of indirect costs between production, resale, and other activities.
    (ii) Examples of indirect costs required to be capitalized. The following are examples of indirect costs that must be capitalized to the extent they are properly allocable to property produced or property acquired for resale:
…………..
(D) Employee benefit expenses. Employee benefit expenses include all other employee benefit expenses (not described in paragraph (e)(3)(ii)(C) of this section) to the extent such expenses are otherwise allowable as deductions under chapter 1 of the Internal Revenue Code. These other employee benefit expenses include: worker's compensation; amounts otherwise deductible or allowable in reducing earnings and profits under section 404A; payments pursuant to a wage continuation plan under section 105(d) as it existed prior to its repeal in 1983; amounts includible in the gross income of employees under a method or arrangement of employer contributions or compensation that has the effect of a stock bonus, pension, profit-sharing or annuity plan, or other plan deferring receipt of compensation or providing deferred benefits; premiums on life and health insurance; and miscellaneous benefits provided for employees such as safety, medical treatment, recreational and eating facilities, membership dues, etc. Employee benefit expenses do not, however, include direct labor costs described in paragraph (e)(2)(i) of this section.

Page Last Reviewed or Updated: 27-Nov-2013