Federal Tax Refunds Provide Liquidity in Bankruptcy

Among the headline-grabbing elements of the CARES Act is the ability of corporations to carry back net operating losses (NOLs) that were generated in taxable years beginning in 2018, 2019 and 2020 to the five preceding taxable years. This has the potential to generate a federal refund of taxes paid for those tax periods. For companies that are in bankruptcy, the ability to obtain liquidity by carrying back the NOL has added value.

However, because the company is in bankruptcy, there are additional considerations regarding the mechanics of an NOL carryback that should be considered based on a taxpayer’s particular situation. This alert highlights some of those considerations.

Methods of NOL Carryback

In general, there are two ways a corporation can carry back an NOL to obtain a federal tax refund. The first is by filing Form 1139, Corporation Application for Tentative Refund.  The second is by filing Form 1120X, Amended U.S. Corporation Income Tax Return. While both approaches carry back an NOL and provide a tax refund, each method has different timing and other considerations.

Corporation Application for Tentative Refund

A corporation application for a tentative refund can be enticing because the taxpayer typically receives the refund within 90 days of the application. However, currently, the timing may be delayed due to COVID-19-related circumstances. This relatively quick processing time comes with a significant limitation: the deadline to file the Form 1139 is generally 12 months from the end of the year in which the loss was generated. The IRS has provided a six-month extension for NOLs that are generated during a taxable year that began in 2018 and ended on or before June 30, 2019.

It is important to note that under this federal tax refund request approach, the refund claim may be reviewed by the IRS and the Joint Committee on Taxation (JCT), if applicable, after the issuance of the refund. Therefore, the proceeds from the refund should be viewed as giving rise to a contingent liability or a loan until the government has completed its review process…

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