Tax Controversy Corner: Watch Out for These NOL Carryover Hazards

Abstract

The net operating loss ("NOL") deduction is ubiquitous, and most tax practitioners have a solid understanding of the rules. Yet, there are two areas that trip up taxpayers and their advisors -- the inability to substantiate the original NOL in an audit of a later tax year, and the application of penalties and interest to deficiencies that are otherwise offset by NOL carrybacks. We know that deductions are "a matter of legislative grace," and taxpayers bear the burden of proving their entitlement to any deductions claimed. This principle applies to NOLs under Code Sec. 172. Code Sec. 172 provides for deductions of NOLs in a taxable year. Code Sec. 172(c) defines an NOL as the excess of deductions over gross income, computed with the modifications stated in Code Sec. 172(d). The amount of the NOL deduction equals the aggregate of the NOL carryovers and NOL carrybacks for the taxable year.