NOL Carryovers – the Theory
Let’s take a short walk down memory lane . . . while we still can.
Generally speaking, the amount by which a business’s expenses for a tax year exceed its gross income for such year represent the business’s net operating loss (“NOL”) for the year. There are many reasons why this may occur. For example, a business just starting out may be slow to generate sales, while also paying or incurring significant start-up costs. Alternatively, a business may belong to a cyclical industry that depends upon the well-being of the economy as a whole; for example, a retail business that depends upon discretionary spending by consumers.
For years, the Code has recognized that a business’s income tax liability for a particular taxable year may not correlate to its overall or historic economic performance. Consider a business that operates at a loss for several years before finding or rediscovering its groove. In order to remain in operation, it borrows from third party lenders (often with the personal guarantee of its owners), or its owners make additional capital contributions. If the business is not permitted to somehow use its losses to “average out” the results of its high-performing and poor-performing years, it would be paying more tax than warranted based on its actual economic results.[i]
That’s the theory.
The TCJA
Prior to the enactment of the Tax Cuts and Jobs Act (the “TCJA”)[ii] in 2017, this business would have been permitted to carry its NOL realized during a tax year back to the two immediately-preceding tax years for the purpose of reducing the business’s taxable income in such years. If, as a result of such reduction, it was determined that the business had overpaid its taxes in either of the carryback years, the business could have claimed a refund for the excess amount of tax paid. In the case of a business that had fallen on some hard times, this recovery of taxes paid in prior years often represented a badly needed infusion of funds.
To the extent the business had NOLs remaining after the two-year carryback, it was permitted to carry them forward for up to twenty years for the purpose of reducing its future taxable income, and the resulting income tax liability, for each of those years.
As a result of the TCJA, the two-year carryback was repealed for an NOL arising in a taxable year beginning after 2017. However, instead of the twenty-year carryforward period, a business with such NOLs was permitted to carry them forward indefinitely until they were exhausted. That said, the TCJA also limited a business’s NOL deduction for a carryover year to 80 percent of its taxable income for such year (determined without regard to the NOL deduction).
The Pandemic
In response to the outbreak of the pandemic and the economic consequences of the measures taken by the government to contain it, Congress enacted the CARES Act in 2020.[iii] Among other things, this legislation modified or delayed the implementation of certain provisions of the TCJA.
It also gave businesses that were being adversely affected by the pandemic an opportunity to obtain additional funding. Specifically, this law provided that any NOL arising in a taxable year beginning after December 31, 2017, and before January 1, 2021, could be carried back to the five taxable years preceding the taxable year of such loss. By reducing its taxable income – and its tax liability – for such earlier years, the business could recover some of the taxes paid for those years. The funds returned to the business could then be used to keep it afloat.
Which brings us to case of the taxpayers described below.[iv]
The Acquisition
Until 2018, Target Corp (“Target”) had served as the common parent of a group of affiliated corporations and, as such, was the group’s agent and assumed responsibility for filing a consolidated corporate tax return on behalf of the entire group for the 2015 through 2018 tax years.
In October 2018, Target was acquired by, and merged into, Acquirer Corp (“Acquirer”), with Acquirer as the surviving corporation. As a result, Acquirer became the “default successor” to Target and “the agent” for its consolidated group’s taxable years through 2018.
The CARES Act
Acquirer’s status as agent by succession for the Target corporate group’s prior tax returns became important following enactment of the CARES Act which, as explained earlier, expanded the ability of corporations to offset tax liabilities from prior years with business losses generated in later years. Corporations could claim these tax benefits by amending prior returns to show they had overpaid in light of the retroactive tax changes.[v]
The Refund Claim
After striking an agreement with the former owners of Target, Acquirer sought to obtain the benefit of the Target group’s NOLs by filing amended returns for the consolidated group from 2015 to 2018 in which it claimed total refunds in excess of $8 million.[vi]
However, the amended returns identified Target, instead of Acquirer, as the filing entity name for each tax year. The filing included a cover letter from Acquirer’s accounting firm (“CPA”).
When the IRS failed to issue a refund within six months of the filing of the refund claim, Acquirer filed suit in Federal District Court to obtain the overpaid taxes.
No Jurisdiction?
The government then moved for judgment on the pleadings.[vii] It asserted that the Court lacked subject matter jurisdiction because Acquirer’s refund claim had not been properly filed. The government stated that, under the Code,[viii] a taxpayer seeking a refund “first must file a valid claim with the Secretary of the Treasury before it is entitled to bring an action in the district court.”
The government argued that Acquirer’s refund claims were not “properly executed” in accordance with the applicable regulations because the returns did not identify the agent; i.e., Acquirer.
The government explained that “[a] taxpayer seeking a refund of taxes erroneously or unlawfully assessed or collected may bring an action against” the Federal government either in District Court or in the Court of Federal Claims; as a prerequisite, however, “a taxpayer must comply with the tax refund scheme established in the Code.” Specifically, a taxpayer may not sue “until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof.”[ix] In order for a return to have been “duly filed,” it must have been “properly executed.”[x]
Acquirer did not dispute that properly executing the amended return on which the refund claim was made was a jurisdictional requirement; still, it resisted the government’s objection and argued that, even if naming Target was erroneous, the Court should overlook that error.
The Court’s Opinion
Unfortunately for Acquirer, the Court agreed with the government.
Did Acquirer Properly Execute the Amended Returns?
The government pointed to a few regulations supporting its argument that by naming Target, the forms for the 2015 to 2018 tax years were not valid refund claims. Chief among these was a regulation explaining that the agent is the “sole agent that is authorized to act in its own name regarding all matters relating to federal income tax liability” for the group.[xi] The government also highlighted regulations instructing that the “consolidated return must be made … for the group by the agent,”[xii] and that “[t]he agent files claims for refund, and any refund is made directly to and in the name of the agent…”[xiii] In light of these requirements, the government stressed that the relevant returns nowhere referenced Acquirer.
Acquirer disagreed that it violated any of the regulations but, according to the Court, its arguments were unavailing. And by highlighting ways in which the Court or the IRS could discover that Acquirer filed the amended returns, Acquirer only underscored the importance of properly naming itself in the first place.
Acquirer contended these regulations did not require that the agent name itself on the amended return. It argued that the regulations[xiv] indicated “nothing about whose name is listed atop the return” and instead merely “describe[] the agent’s legal authority to bind the affiliated group.” Acquirer argued that this requirement’s satisfaction could be inferred from other information indicating Acquirer “in fact ‘filed’ the [Target] Amended Returns.” First, it stated that it was reasonable to infer Acquirer filed the returns from the very impossibility of a liquidated corporation filing them: “since [Target] did not exist, and … [Acquirer] was the sole agent …, the only logical inference from the pleadings and exhibits was that [Acquirer] filed the refund claims.” It also pointed to other documents and exhibits that support the inference that Acquirer authorized the filing of the returns. It placed particular emphasis on the signature of its Chief Financial Officer in his capacity as “CFO” or “Officer,” noting that even though this title did not reference Acquirer, other relevant exhibits before the Court, including a declaration, supported the signatory as holding that position on behalf of Acquirer.
The Court responded that, just because the it could piece together this information did not mean the IRS could have done so, nor did it render the form validly executed. Indeed, the Court continued, “the IRS has the right to insist that its regulations be followed.” According to the Court, it was not enough that “somewhere under the Commissioner’s roof is the information which might enable him to pass on a claim for refund.”
If anything, the Court observed, Acquirer’s “arguments only underscore the critical role of a return naming the filer.” The regulations identify this importance by saying that “[t]he agent files claims for refund, any refund is made directly to and in the name of the agent.”[xv] In other words, the name of the filer on the return mattered.
“Moreover,” the Court continued, “there is little to support that the regulations merely require the agent ‘cause’ the filing of refund claims.” Acquirer’s contention, the Court stated, “reads out of [the Regulation] that the agent acts ‘in its own name.’” This applies comprehensively, too, “regarding all matters relating to the federal income tax liability.” Here, Acquirer failed to act in its name by listing Target as the taxpayer on the amended returns.
An agent’s self-identification, the Court explained, was not just practically important but also reflected the agent’s legal relationship to affiliates. The point of a consolidated return, the Court stated, was that, rather than “requiring each member company of ‘[a]n affiliated group of corporations’ to file a separate tax return, the Code permits the group to file a single consolidated return,” through the agent. That single return is “based on the legal fiction that the consolidated group of corporations is ‘for purposes of United States income tax, one taxpayer.’” The agent is that “one taxpayer.” More than simply “causing” a return’s filing, the agent “files the return, pays the tax, receives any refunds, and generally deals with the IRS.” A requirement that the agent name itself as the filer reflected the agent’s role as the representative of the group.
The Court found that this role and naming requirement was well-supported by caselaw.[xvi]
Still, Acquirer argued that the amended returns had to be in Target’s name because Target was the common parent for the relevant tax years, in respect of which the refund was claimed. Acquirer also emphasized the oddity of naming itself when it “had no connection to the affiliated group during the relevant years” and “had returns of its own for those years.”
The Court rejected Acquirer’s position, stating that its arguments ran “headfirst into its factual allegation that, by succession as the common parent, it “bec[a]me the ‘agent’ … for the [Target] consolidated group’s 2015 through 2018 taxable years” and was thereby responsible for filing amended returns, despite having no connection to those prior years.
The Court pointed out that the Treasury’s regulations spotlighted this arrangement. They referred to the agent for a “completed year” as possibly a “default successor” of a common parent, which was relevant in the present case, where the prior common parent had been liquidated.[xvii] The same regulations also provided an analogous example in which the IRA explained that where a parent of a consolidated group merged with and into an acquiring corporation, the latter was the “default successor and agent for the [past] group” and “must file” the past group’s consolidated return for a pre-merger year.[xviii] Therefore, Acquirer’s arguments “defending the propriety of naming a defunct parent company on the amended tax returns [were] unavailing.”
Did Acquirer Justify Ignoring the Error?
Alternatively, Acquirer argued that the Court should overlook any error
because it “had a good excuse … for failing to comply with either an unimportant requirement or one unclearly or confusingly stated in the regulations,” so as to qualify under the substantial compliance doctrine. Acquirer contended that any requirement to name itself was confusing because it was “counterintuitive and is unimportant” because it was merely “procedural.”
The Court was not persuaded. The substantial compliance doctrine, it stated, “should be interpreted narrowly.” According to the Court, this holds all the more so in the context of consolidated returns because the “privilege” of consolidated return filing is granted “upon the condition that all corporations” in a group “consent to all the consolidated return regulations.”[xix] There was no “good excuse” for non-compliance in the present case, the Court continued, where Acquirer “relied on a large accounting firm” (CPA) to prepare the forms and the requirement for the correct name was fundamental, if only to ensure the correct party was repaid.[xx] Acquirer was no doubt “well aware that a substantial tax deduction was at stake.” These considerations lead the Court to reject the applicability of substantial compliance.
Acquirer also argued that the Court should have declined to “elevate the form of … claims over their substance” given the IRS received adequate notice and would not be prejudiced. The Court noted that Acquirer’s brief did not identify any authority in the context of a consolidated return to support its request.[xxi] According to the Court, when the conditions for substantial compliance “are not satisfied, it makes compellingly good sense to hold a taxpayer to the requirements of the tax code.”
Finally, Acquirer argued that a “plausible inference should be made” that the IRS waived the regulatory requirements by investigating the claim. The Court responded, “But, in its cursory point, [Acquirer] acknowledged it [lacked] facts or allegations that could come close to supporting a plausible inference the Commissioner “clear[ly] … understood the specific claim that was made even though there was a departure from form in its submission.” Acquirer’s failure to prove such a waiver was “fatal,” the Court added.
Court’s Conclusion
By submitting amended tax returns in Target’s name, Acquirer did not “properly execute” those returns by providing the name of a defunct corporation rather than its own name. As a consequence, the amended returns were not “duly filed” with the IRS.
With that, the Court dismissed Acquirer’s claims for lack of subject matter jurisdiction; however, it did so without prejudice, meaning that Acquirer could remedy its procedural error and resubmit its claim, provided it did so on a timely basis because the dismissal did not pause the running of the limitations period.
In Summary
Who said it was easy to secure a refund of an overpayment of income tax? The “refund regime” can be every bit as challenging as the regime for assessing and collecting an income tax deficiency.
The taxpayer has to determine whether there has been an overpayment of tax in an earlier tax year – perhaps paid because the taxpayer missed the filing deadline for Tax Court and didn’t have a sufficiently equitable “excuse” for the Court to waive it, or because the taxpayer resided in one of appellate jurisdictions that still viewed the 90-day rule as jurisdictional[xxii] – and, having done so, it must be prepared to prove it.
[i] I imagine that few thoughtful people would take issue with this statement. Having said that, the same thoughtful people will certainly have differing opinions over which expenditures of a business should be considered in computing its NOLs, how to curb abuses in the creation of NOLs, and the periods to which such NOLs may be carried, among other relevant topics. Policy questions.
[ii] Pub. L. 115-97.
[iii] See Pub. L. No. 116-136, § 2303(b).
[iv] pH Beauty Holdings III, Inc., v. U.S., No. 25 CV 13467 (N.D. Ill. 2026).
[v] Reg. Sec. 301.6402-3(a)(5).
[vi] In case you’re wondering, even when there is an “ownership change,” IRC Sec. 382 limits the carryforward of pre-change losses to post-change years. The issue in the present case involved a carryback. Of course, the SRLY (separate return limitation year) rules would still have to be considered if the carryback involved a specific member’s separate return (pre-consolidated) year. Reg. Sec. 1.1502-21.
[vii] Under Federal Rule of Civil Procedure 12(c).
[viii] IRC Sec. 7422.
[ix] IRC Sec. 7422(a).
[x] Reg. Sec. 301.6402-3(a)(5).
[xi] Reg. Sec. 1.1502-77(a)(1).
[xii] Reg. Sec. 1.1502-75(h)(1).
[xiii] Reg. Sec. 1.1502-77(d)(5).
[xiv][xiv] Reg. Sec. 1.1502-77(d)(5) and (c).
[xv] Reg. Sec. 1.1502-77(d)(5).
[xvi] The Court cited an opinion of the Second Circuit Court of Appeals to support its statement. The higher court explained the mechanics of consolidated returns as follows: they “are filed in the name of the ‘common parent’, who acts as the agent for each subsidiary in the group and acts on behalf of the group in all matters related to tax liability for the consolidated group.” In re Prudential Lines Inc., 928 F.2d 565, 569 (2d Cir. 1991).
[xvii] Reg. Sec. 1.1502-77(c).
[xviii] Reg. Sec. 1.1502-77(g)(8)(ii).
[xix] IRC Sec. 1501.
[xx] Reg. Sec. 1.1502-77(d)(5) (“The agent files claims for refund, and any refund is made directly to and in the name of the agent….”).
[xxi] “[T]axpayers, by electing to file consolidated returns, have necessarily consented to all regulations in effect … prescribed by law for filing returns.”
[xxii] Remember that? The Notice of Deficiency, or 90-Day Letter? Don’t get me started. Congress intended the 90-day deadline as jurisdictional. The Tax Court itself was of the same opinion. Then several federal Appellate Courts revised the rule.