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Thursday, February 05, 2009

NOL CARRYBACK WAIVER CAN BE VOIDED IN BANKRUPTCY

A taxpayer with a net operating loss (NOL) can usually carryback that NOL for 2 years, and apply it in those prior years. Typically, the carryback will result in a refund of income tax. If the taxpayer makes an irrevocable election, it can forego the carryback and thus use the NOL in future years only.

Daniel Taylor had an NOL from his business. Instead of carrying it back and receiving a refund, he waived the carryback so he could use it against future expected income. After such waiver, he declared bankruptcy. The bankruptcy trustee sought to avoid the carryback waiver - if he could do so it would generate a refund in a prior year which would belong to the bankruptcy estate.

The bankruptcy trustee had to overcome a number of hurdles to "avoid" the waiver as a pre-petition transfer of property made within 2 years of a bankruptcy filing. Generally, such transfers are avoidable if the trustee can show that (i) there was a transfer of an interest of the debtor in property, (ii) the transfer occurred within two years preceding the petition date, (iii) the debtor received less than reasonably equivalent value in exchange for the transfer, and (iv) the debtor was either insolvent on the date of the transfer or became insolvent as a result of the transfer.

Thus, assuming that items (ii) and (iv) were met, the trustee first had to show that the NOL carryback waiver was "an interest...in property." Holding that the practical effect of the waiver was a relinquishment of a present tax refund amount in favor a speculative future refund, the court found that "tax refund" that was available was an interest in property.

Next, the trustee had to show there was a "transfer" of that property to someone (here, the United States). The court found that a transfer did occur, by reason of the U.S. not having to pay a refund to Mr. Taylor. A bit of a stretch, but let's keep going.

Lastly, the trustee had to show that it could override an election that is "irrevocable" under the Internal Revenue Code. Here, the court noted that the trustee was not seeking to "revoke" the carryback waiver, but to "avoid" it. Noting that bankruptcy trustee avoidance powers are frequently used to undo transactions that are irrevocable as to the debtor, the court indicated that it was not constrained by the irrevocable nature of the waiver.

Consequently, the trustee was able to surmount all of these barriers, was able to avoid the prior waiver of the NOL carryback, and thus was able to capture the NOL carryback refund.

U.S. v. KAPILA
, 103 AFTR 2d 2009-XXXX (D.C. Southern District of Florida), 08/18/2008

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