Audit Report 2022-35-049 — Refund Claims on Form 1139 Under CARES Act Carryback Provisions (TIGTA)
- Document type
- report
- Date
- 2022-08-31
Summary
A Treasury Inspector General for Tax Administration final audit report, Report Number 2022-35-049, issued August 31, 2022 to the Commissioner of Internal Revenue, on IRS efforts to ensure corporate compliance with the CARES Act net operating loss carryback provisions claimed on Form 1139. The report states that from March 27, 2020, to March 31, 2021, 17,537 taxpayers submitted Form 1139 covering 19,262 loss tax years, and the IRS issued $17.4 billion in tentative refunds to 12,119 of them. It finds that few related Forms 1120 were selected for examination, and that in five of eight closed Small Business/Self-Employed examinations reviewed, part of the tentative refunds should have been recaptured. TIGTA made three recommendations to that division, and IRS management agreed with all three. Parts of the report are redacted.
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Full text
TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION
Compliance Efforts Are Needed to Address Refund
Claims Reported on Form 1139 That Are Based on the
CARES Act Net Operating Loss Carryback Provisions
August 31, 2022
Report Number: 2022-35-049
This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted from this document.
1
TIGTACommunications@tigta.treas.gov | www.treasury.gov/tigta
HIGHLIGHTS: Compliance Efforts Are Needed to Address Refund Claims Reported on
Form 1139 That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Final Audit Report issued on August 31, 2022 Report Number 2022-35-049
Why TIGTA Did This Audit What TIGTA Found
This audit was initiated to assess During the period March 27, 2020, to March 31, 2021,
the IRS’s efforts to ensure 17,537 taxpayers submitted Form 1139 involving carrybacks to
corporate taxpayers’ compliance cover 19,262 loss tax years. The IRS issued a total of $17.4 billion in
with the net operating loss tentative refunds to 12,119 of these taxpayers. Despite the large
provisions pertaining to volume of Forms 1139 submitted, the business tax returns selected
Form 1139, Corporate Application for examination represent a relatively low percentage of net
for Tentative Refund. operating loss tax years claimed on the Form 1139. From March 27,
2020, through July 26, 2021, the Small Business/Self-Employed
Impact on Tax Administration Division selected a total of 12,760 Forms 1120, U.S. Corporation
Provision 2303 of the Coronavirus Income Tax Return, for examination of which 36 (less than
Aid, Relief, and Economic Security 0.30 percent) involved a “loss” year claimed on the Form 1139.
(CARES) Act, signed into law on Similarly, the Large Business and International Division selected a
March 27, 2020, made several total of 5,214 Forms 1120 for examination of which 406 (7.8 percent)
modifications that temporarily involved a “loss” year claimed on the Form 1139. Further, the IRS is
repealed certain restrictions not assessing the potential risk these CARES Act provisions pose to
imposed by the Tax Cuts and Jobs tax administration in order to determine whether to adjust
Act affecting net operating losses. examination coverage.
The CARES Act allows a taxpayer TIGTA reviewed eight Form 1120 examinations that the
with a net operating loss arising in Small Business/Self-Employed Division closed and found the IRS
a taxable year beginning in 2018, examinations resulted in return adjustments on five cases
2019, or 2020 to carry that loss (62.5 percent) that reduced the net operating loss that was carried
back to each of the five preceding back. Per the net operating loss provisions, Internal Revenue Code
tax years. The taxpayer can also § 172, part of the tentative refunds issued in the five cases should
elect to relinquish the entire have been recaptured. The examiner did not always take the steps
carryback period for any taxable to recapture the tentative refund issued to the taxpayer. TIGTA
year’s net operating loss and performed similar reviews of Large Business and International
instead carry all net operating Division examination cases and did not find any exceptions.
losses forward. Once made, this
election is irrevocable. After TIGTA shared these observations with the Small Business/
Self-Employed Division, management took immediate corrective
actions to update the examination guidance for both the Small
Business/Self-Employed and Large Business and International
Divisions and is in the process of taking the steps necessary to
recover the excess tentative refunds issued.
What TIGTA Recommended
TIGTA recommended that the Small Business/Self-Employed Division:
1) track and monitor the examination results for the 25 open
examinations of Forms 1120 with reported net operating losses and
an associated Form 1139 presented in this report (excluding Joint
Committee Refund cases); 2) use the examination results from
Recommendation 1 to assess whether to increase the number of
examinations of Forms 1120 with reported net operating losses and
an associated Form 1139; and 3) review the examination results and
computations of proposed net operating loss adjustments for the
25 open examinations presented in this report (excluding Joint
Committee Refund cases), to determine if the interim guidance
regarding net operating losses is being properly followed. IRS
management agreed with all three recommendations.
U.S. DEPARTMENT OF THE TREASURY
WASHINGTON, D.C. 20024
TREASURY INSPECTOR GENERAL
FOR TAX ADMINISTRATION
August 31, 2022
MEMORANDUM FOR: COMMISSIONER OF INTERNAL REVENUE
FROM: Heather M. Hill
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – Compliance Efforts Are Needed to Address Refund
Claims Reported on Form 1139 That Are Based on the CARES Act Net
Operating Loss Carryback Provisions (Audit # 202130525)
This report presents the results of our review to assess the Internal Revenue Service’s efforts to
ensure corporate taxpayers’ compliance with the net operating loss provisions pertaining to
Form 1139, Corporate Application for Tentative Refund, application under the Coronavirus Aid,
Relief, and Economic Security Act of 2020. 1 This review is part of our Fiscal Year 2022 Annual
Audit Plan and addresses the major management and performance challenge of Improving Tax
Compliance.
Management’s complete response to the draft report is included as Appendix III.
Copies of this report are also being sent to the Internal Revenue Service managers affected by
the report recommendations. If you have any questions, please contact me or Matthew A. Weir,
Assistant Inspector General for Audit (Compliance and Enforcement Operations).
1
Pub. L. No. 116-136, 134 Stat. 281.
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Table of Contents
Background .....................................................................................................................................Page 1
Results of Review .......................................................................................................................Page 4
Few Businesses Filing Form 1139 Have Their Corporate
Income Tax Returns Selected for Examination Despite the
Large Amount of Tentative Refunds Issued ...............................................................Page 4
Recommendation 1: ...................................................................Page 8
Recommendation 2: ...................................................................Page 9
Examiners Did Not Always Consider the Impact
Form 1120 Examination Results Had on Net Operating
Loss Carrybacks.....................................................................................................................Page 9
Recommendation 3: ...................................................................Page 11
Appendices
Appendix I – Detailed Objective, Scope, and Methodology ................................Page 12
Appendix II – Form 1139, Corporation Application for Tentative
Refund ......................................................................................................................................Page 14
Appendix III – Management’s Response to the Draft Report .............................Page 15
Appendix IV – Glossary of Terms ...................................................................................Page 19
Appendix V – Abbreviations.............................................................................................Page.20
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Background
Fluctuations in income and expenses can cause a taxpayer to have substantial profits in one tax
year and losses in another. For business returns, a net operating loss (NOL) generally occurs
when a taxpayer’s allowable deductions exceed its gross income for a tax year, resulting in
negative income. 1 A taxpayer with an NOL generally does not owe any income taxes and may
be able to carry back any excess loss to offset income reported in earlier tax years, resulting in a
refund of taxes already paid. Any loss remaining after applying the NOL to preceding tax years
may be carried forward to lower taxes in future tax years. In general, for NOLs arising in tax
years beginning after Tax Year (TY) 2017, the Tax Cuts and Jobs Act (TCJA) removed the option
for most entities to carry back an NOL and allowed the taxpayer to carryforward an NOL subject
to an 80 percent of taxable income limitation; 2 however, as described below, subsequent
legislation provided for NOL carrybacks.
CARES Act-enacted NOL legislation changes
To provide liquidity to businesses during the COVID-19 pandemic, the Coronavirus Aid, Relief,
and Economic Security (CARES) Act of 2020, signed into law on March 27, 2020, included tax
measures to help businesses by reducing certain tax obligations. 3 In some cases, the tax
measures, such as the changes to NOL rules, led to tax refunds.
The CARES Act reversed the TCJA restriction on NOL carrybacks. Section 2303 of the CARES Act
allows a taxpayer with a NOL arising in a taxable year beginning after December 31, 2017, and
before January 1, 2021, i.e., TYs 2018, 2019, or 2020, to carry that loss back to each of the five
taxable years preceding the taxable year of such loss while also providing a temporary repeal of
the 80 percent taxable income limitation for NOL deductions enacted by the TCJA. Taxpayers
may elect to relinquish the entire carryback period for any taxable year’s NOL and instead carry
all NOLs forward. Once made, this election is irrevocable.4 Figure 1 shows the impact that the
CARES Act has on NOL carryback and carryforward rules.
1
See Appendix IV for glossary of terms.
2
Pub. L. No. 115-97, 131 Stat 2054 (2017).
3
Pub. L. No. 116-136, 134 Stat. 281.
4
Internal Revenue Code (I.R.C.) § 172(b)(3).
Page 1
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Figure 1: NOL Carryback and Carryforward Rules Due to the CARES Act
Limitation on NOL Utilization in Carryforward Period
Carryback Carryforward Tax Years Tax Years Tax Years
Period Period Before TY 2018 2018 - 2020 After TY 2020
Pre-2018 NOLs 2 years 20 years Not limited Not limited Not limited
TYs 2018 - 2020 NOLs 5 years Indefinite N/A Not limited 80% limitation
Post-2020 NOLs N/A (no Indefinite N/A N/A 80% limitation
(TCJA) carryback)
Source: TIGTA analysis of the TCJA and CARES Act.
The TCJA made the corporate tax rate a flat 21 percent effective for taxable years beginning
after December 31, 2017, regardless of tax income level. Tax years prior to TY 2018 generally
had higher tax rates (see Figure 2).
Figure 2: TY 2013 to TY 2017 Federal Corporate Tax Rates
Taxable Income Of the
Tax Is
Over But Not Over Amount Over
$0 $50,000 15% $0
$50,000 $75,000 $7,500 + 25% $50,000
$75,000 $100,000 $13,750 + 34% $75,000
$100,000 $335,000 $22,250 + 39% $100,000
$335,000 $10,000,000 $113,900 + 34% $335,000
$10,000,000 $15,000,000 $3,400,000 + 35% $10,000,000
$15,000,000 $18,333,333 $5,150,000 + 38% $15,000,000
$18,333,333 N/A 35% $0
Source: 2013 - 2017 Instructions for Form 1120, U.S. Corporation Income Tax Return.
The ability of businesses to carry back NOLs from TY 2018 through TY 2020 to earlier tax years,
due to CARES Act provisions, tends to increase the value of the carryback amounts. For
example, a taxpayer with taxable income between $10 million and $15 million in TY 2013 and an
NOL of $1 million in TY 2018 could carry back the loss to TY 2013 and generate a refund of
$350,000 ($1 million x 35 percent). Whereas, prior to the CARES Act, the same NOL would only
result in a refund of $210,000 ($1 million x 21 percent) based on carrying the NOL forward.
Process to carryback losses under the CARES Act
Business taxpayers with a NOL have a choice of two methods to carry back their loss, each of
which has separate rules. 5 A taxpayer may:
5
Revenue Procedure 2020-24, effective Apr. 9, 2020.
Page 2
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
• File an Application for Tentative Refund. The Form 1139, Corporation Application for
Tentative Refund, generally must be filed within one year after the end of the tax year
with the reported NOL. A taxpayer can file one form to
carry back its loss to all applicable preceding gain years.
The primary advantage of filing a tentative refund Taxpayers generally
application using Form 1139 is that the original return with receive refunds quicker by
the NOL does not have to be completely processed by the filing Form 1139 than
Internal Revenue Service (IRS) before the refund can be amending returns.
approved, thus making the refund “tentative.” This means
the refund can be issued prior to verification of the posted
tax return. Additionally, a tentative refund is processed prior to referral for examination.
While the IRS is required to process tentative refund applications within 90 days, interest
must be paid on refunds that are not issued within 45 days. 6
• File an amended return. Unlike the tentative refund, an amended return has to be filed
for each carryback year and must generally be filed within the statutory period of three
years from the due date of the loss year return, including extensions. A carryback filed
on an amended return is subject to examination criteria on the loss/gain years before
allowing the claim. While the IRS is not statutorily required to process amended return
carryback claims within 90 days, interest must be paid on refunds that are not issued
within 45 days. 7
The process for submitting Form 1139 is by paper only. However, due to the COVID-19
pandemic, the IRS temporarily established an e-fax submission method for Form 1139 to
enable image-scanning and loading into IRS systems. This facilitated employees’ ability to
review Form 1139 cases while on extended telework. The e-fax line was operational from
April 17, 2020, to December 31, 2020.
Both the Treasury Inspector General for Tax Administration (TIGTA) and the Government
Accountability Office have reviewed the IRS’s processing of the tentative refund applications.
TIGTA’s review found some business tentative refund applications associated with identity theft
tax accounts and/or with a recent and significant address change were not referred for required
fraud review. Additionally, some tentative refund applications were erroneously processed after
the filing deadline. 8
The Government Accountability Office found the IRS did not timely process tentative refund
applications resulting in a backlog. The IRS started to miss the 90-day statutory requirement in
September 2020 and missed it throughout 2021. As of November 2021, the average time for
processing all carryback refunds was 166 days. 9
6
I.R.C. § 6411(b) and I.R.C. § 6611(e).
7
I.R.C. § 6611(e).
8
TIGTA, Report No. 2021-46-035, Assessment of Processes to Verify Tentative Carryback Refund Eligibility
(June 2021).
9
Government Accountability Office, GAO-22-105291, COVID-19 Significant Improvements Are Needed for
Overseeing Relief Funds and Leading Responses to Public Health Emergencies (Jan. 2022).
Page 3
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Results of Review
From March 27, 2020, to March 31, 2021, the IRS received 17,537 Forms 1139 involving
carrybacks from business taxpayers covering 19,262 loss tax years. 10
The IRS *********************2*******************************
*****************************2******************************** **********2*********
***********2**************. 11 **************2****************** ***********2**********
************2************** **********2**********
• *********************2******************** *********2*********.
• *********************2*********************************
*******************2********
• *******************2*******************************
Because the Form 1139 can be used to claim tentative refunds for different reasons, e.g., unused
general business credit, unused research credit, net capital loss, etc., the IRS ********2************
***************************2****************************************************, for this review, the
IRS provided Form 1139 data that involve carrybacks regardless of the reason.
Few Businesses Filing Form 1139 Have Their Corporate Income Tax Returns
Selected for Examination Despite the Large Amount of Tentative Refunds
Issued
According to the IRS, refunds from Form 1139 are a priority and should be issued as timely as
possible. If the Form 1139 was able to be processed, the IRS allowed tentative refunds
immediately. If problems are found later, i.e., through examination, the IRS is required to
reverse the tentative refund and recapture the refunds from the taxpayers. To provide financial
assistance to businesses quickly, there was an inherent risk that some refunds were issued based
on intentionally or unintentionally overstated NOL carryback amounts on Forms 1139 and the
Government may not recover the associated erroneous refund payments.
A large amount of tentative refunds has been issued
We matched the 17,537 taxpayers referenced previously to the IRS’s tentative refund data. We
estimate that as of May 27, 2021, the IRS issued $17.4 billion tentative refunds based on
submitted Forms 1139. Figure 3 shows that 12,119 taxpayers were allowed tentative refunds. 12
10
The tax year count is higher than the number of taxpayers because some taxpayers claimed losses for more than
one tax year.
11
See Appendix II for a copy of Form 1139.
12
Of the 12,119 taxpayers, 97 had a total of $331.4 million refunds reversed.
Page 4
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Figure 3: Form 1139 Tentative Refunds Issued
Applied Carryback to “Gain” Tax Year Tentative Refunds Issued
2013 $2,242,815,830
2014 $4,137,020,347
2015 $2,643,797,635
2016 $4,441,298,387
2017 $2,666,284,521
2018 $1,137,412,476
2019 $170,704,004
Total $17,439,333,200
13
Number of Taxpayers 12,119
Source: TIGTA analysis of the IRS’s Form 1139 and refund data.
Given that the IRS ****************************************2***************************************
******2****** the IRS cannot quantify the ************2*********************************, we were
unable to estimate the percentage of the $17.4 billion tentative refunds associated with NOL
carrybacks.
As explained previously, the CARES Act allowed taxpayers with an NOL arising in TYs 2018, 2019,
or 2020 to carry that loss back to each of the five tax years preceding the tax year of such loss.
This means TY 2013 would be the earliest eligible year, i.e., for a TY 2018 NOL, and TY 2019
would be the last eligible year, i.e., for a TY 2020 NOL. The Small Business/Self-Employed
(SB/SE) and Large Business and International (LB&I) Divisions have not adjusted their annual
examination plans or return selection methodology to address NOL carryback changes under
the CARES Act.
According to the Standards for Internal Control in the Federal Government, a strong control
environment requires management to identify, analyze, and respond to risks. 14 The
identification of risks includes considering changes within the entity’s external environment
factors, such as new or amended laws and regulations. The enactment of the CARES Act
represents new risks and the IRS should consider the impact on its compliance enforcement
efforts.
13
This is less than 17,537 taxpayers because not all Forms 1139 that the IRS received had been processed (still open),
and some Forms 1139 were not valid.
14
Government Accountability Office, GAO-14-704G, Standards for Internal Control in the Federal Government
(Sept. 2014).
Page 5
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Forms 1139 are not separate tax modules, i.e., accounts, as
they report adjustments made by the taxpayer due to NOL The SB/SE and LB&I
deductions and other adjustments, such as credits based on Divisions have not adjusted
the taxpayer’s originally filed Form 1120. The IRS selects their annual examination
Form 1120 for examination without regard to the Form 1139 plans or return selection
filing. When examining a Form 1120 return, the examiner methodology to address
would need to consider all adjustments, e.g., Form 1139, NOL carryback changes
associated with that tax year’s Form 1120 return as part of the under the CARES ACT.
required audit steps.
According to the SB/SE Division, it has a workstream that conducts examinations of taxpayer
claims, and although tentative allowances claimed on Form 1139 are not claims for refund, they
are included within the Form 1120 claim workstream. However, the SB/SE Division has not
implemented additional audit selection steps to identify Forms 1139 for examination based on
potential inflated NOLs.15 Moreover, the SB/SE Division is not specifically tracking examination
results of NOLs in which the taxpayer filed a Form 1139 associated with the NOL. For example,
when NOLs are adjusted, the examination results are not summarized.
Although tentative allowances claimed on Form 1139 are not claims for refund, the LB&I
Division also includes them within the Form 1120 claim workstream. However, it does not
specifically track examination results of NOLs in which the taxpayer filed a Form 1139. During
the workload selection process, the LB&I Division treats all claims for refunds and requests for
tentative allowances the same. In the examination, the LB&I Division audits the tax return filed
by the taxpayer and the claim, if any.
Few Form 1120 examinations have been conducted to address the NOL year claimed on
the Form 1139
An IRS examination is a review of an organization's accounts and financial data to ensure that
information is reported correctly according to the tax laws and to verify that the reported tax
amount is correct. Examinations are a critical Government control procedure.
The IRS may review any claim for refund or credit. However, the IRS must review a refund or
credit of more than $2 million ($5 million for C corporations) and provide a report to the Joint
Committee on Taxation, i.e., referred to here as Joint Committee Refund Case. A Joint
Committee Refund Case is assigned to an IRS examiner and either examined or surveyed. 16 The
tentative refund claimed on the Form 1139 could give rise to a Joint Committee Refund Case,
and the tentative refund could be paid prior to the IRS’s review.
In December 2014, the Tax Increase Prevention Act of 2014 increased the threshold for Joint
Committee Refund Cases from $2 million to $5 million for C corporations. 17 As a result, fewer
C corporation Forms 1139 are now subject to Joint Committee review as compared to when the
NOL five-year carryback was allowed previously (before the TCJA was enacted).
15
A claim for refund is an amended return or written request that asks for some amount of money to be refunded,
whether or not it also involves an abatement.
16
A survey is a decision to accept a return without examination.
17
Pub. L. No. 113-295 (2014).
Page 6
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
We analyzed the Forms 1120 that the SB/SE and LB&I Divisions selected for examination on or
after the CARES Act was enacted and compared those to the Forms 1139 received during the
period March 27, 2020, to March 31, 2021. 18 We found that the Forms 1120 selected for
examination represent a relatively low percentage of NOL tax years claimed on the Form 1139.
As of July 26, 2021, the SB/SE Division selected a total of 12,760 Forms 1120 for examination.
Comparison of the selected returns against the Forms 1139 received disclosed that only 36 out
of the 12,760 Form 1120 returns (less than 0.30 percent) involved a “loss” year claimed on the
Form 1139 (see Figure 4). 19
Figure 4: Comparison of SB/SE Division Selected
Forms 1120 for Examination to Forms 1139 Received
Number of Number of Forms 1120 That
Examination Status as of
Forms 1120 Has a Tax “Loss” Year on
July 26, 2021
Selected Forms 1139
Closed 1,631 8
Closed As Not Examined 3,149 3
Still Open 7,980 25
Total 12,760 36
Source: TIGTA analysis of Form 1139 and SB/SE Division Form 1120 data.
As of July 2021, the LB&I Division selected a total of 5,214 Forms 1120 for examination.
Comparison of the selected returns against the Forms 1139 received disclosed
406 of the 5,214 Form 1120 returns (7.8 percent) involved a “loss” year claimed on the
Form 1139 (see Figure 5).
18
The IRS does not have a return “select date” field. As such, the IRS used the “creation date” when providing the
Form 1120 data extract to TIGTA. The creation date is the date the return record was established on the Audit
Information Management System.
19
By comparison, audit coverage rates for corporations with assets between $10 million and $50 million for Tax
Year 2019 was 1.1 percent, and the audit coverage raises to 24 percent for corporations with assets of $20 billion or
more. IRS Data Book, Fiscal Year 2021, p. 36, Table 17.
Page 7
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Figure 5: Comparison of LB&I Division Selected
Forms 1120 for Examination to Forms 1139 Received
Number of Number of Forms 1120 That
Examination Status
Forms 1120 Has a Tax “Loss” Year on
as of July 2021
Selected Forms 1139
Closed in Fiscal Year (FY) 2020
20 21 *1*
Closed in FY 2021 250 8
Closed as Not Examined in 78 *1*
21
FY 2020
Closed as Not Examined in FY 2021 1,926 88
Open (passed the “selected but not 2,939 308
assigned” stage)
Total 5,214 *1*
Source: TIGTA analysis of Form 1139 and LB&I Division Form 1120 data.
The IRS agreed with the data presented in Figures 4 and 5. However, the IRS noted the data in
those two figures do not include taxpayers that could have filed the Form 1139 as a result of the
CARES Act but were selected for examination prior to March 27, 2020. For example, a TY 2018
Form 1120 return examination started in January 2020 would be excluded in TIGTA’s review. We
purposely focused on returns selected on or after March 27, 2020, because we wanted to assess
the IRS’s actions to ensure compliance with the CARES Act after enactment. Forms 1120
selected prior to March 27, 2020, would not represent intentional coverage of Form 1139 NOL
carryback impact under the CARES Act.
The IRS also stated that TIGTA started this review too early in the examination "selection"
process to get a good match against Forms 1139. Many of the Forms 1139 were not yet
received when return examination started in FY 2020. Examinations started in early to mid-2020
would not have been "in lieu of Form 1139 claims" because the claims would not yet have been
filed or sent to the field. We acknowledge this; however, given the new NOL provisions under
the CARES Act, we believe it is important to catch any problems early for timely correction. As
evidenced in the next section, we identified a problem in need of immediate action in order to
protect the Government’s revenue.
According to the IRS, the volume of cases available for examination is taxpayer driven. The IRS
does not have control over the volume of Forms 1139 received. The IRS only has control over its
examination plan which, according to the IRS, provides balanced examination coverage across
the various workstreams. However, despite the increase in the number of Forms 1139 filed, the
IRS is not assessing the potential risk these CARES Act provisions pose to tax administration in
order to determine whether to adjust examination coverage if warranted. As stated previously,
the Standards for Internal Control in the Federal Government requires management to identify,
20
According to the LB&I Division, there could be some 2018 and 2019 Form 1120 returns selected prior to
March 27, 2020, that the taxpayer later filed Form 1139 to carry back the NOL for tentative refund under the CARES
Act not included in the analysis.
21
According to the LB&I Division, training contributed to cases closed in FYs 2020 and 2021 as not examined. To
ensure a sufficient number of returns, the training managers requested more returns than ended up being worked.
Page 8
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
analyze, and respond to risks. The identification of risks includes considering changes within the
entity’s external environment factors, such as new or amended laws and regulations. We believe
the IRS should adjust the examination plan to provide an increase in specific audit coverage for
Form 1139 filings that surged as a result of the CARES Act enactment.
Given so few examinations of Form 1120 returns involving the tax year claimed on Forms 1139
(see Figures 4 and 5), the risk increases that the Government paid refunds to taxpayers based on
inaccurate Forms 1139. The IRS could benefit from implementing additional audit selection
processes that consider the risk of potential overstated refunds based on Form 1139 evaluation
experience. The examination results specific to the Form 1139 filings should be tracked and
provided to management to identify the Form 1139 filings risk level. The examination data will
enable management to implement the most appropriate examination coverage and additional
audit selection processes based on the level of risk found.
The Commissioner, SB/SE Division, should:
Recommendation 1: Track and monitor examination results for the 25 “still open”
examinations of Forms 1120 with reported NOL and an associated Form 1139 reported in
Figure 4 of this report, excluding Joint Committee Refund cases which currently have specific
monitoring requirements in place.
Management’s Response: IRS management agreed with this recommendation and
will track and monitor the results of these 25 “still open” examinations for a maximum
period of 18 months.
Recommendation 2: Use the examination results from Recommendation 1 to assess whether
to increase the number of examinations of Forms 1120 with reported NOL and an associated
Form 1139.
Management’s Response: IRS management agreed with the recommendation and will
analyze the examination results for the 25 “still open” cases referenced in
Recommendation 1. Based on their analysis, the IRS will determine if an increase in
examinations is warranted for Forms 1120 with a reported NOL and an associated
Form 1139 and make recommendations as appropriate.
Examiners Did Not Always Consider the Impact Form 1120 Examination
Results Had on Net Operating Loss Carrybacks
To determine what the IRS found from its examinations of Forms 1120 involving a tax year
claimed as the “loss” year on Forms 1139, we reviewed pertinent IRS examination results and
documentation.
SB/SE Division examinations
We reviewed all eight Form 1120 examinations that the SB/SE Division closed as shown in
Figure 4. For each of the eight cases, we looked at the Form 1139 pertaining to the tentative
refund claims and examination results to review the tentative refund claims and the results of
the SB/SE Division’s examination. We found the IRS examination resulted in return adjustments
Page 9
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
on five (62.5 percent) of the eight cases that reduced the NOL amount that was carried back.
There were no changes for the three remaining cases.
Per NOL provisions in Internal Revenue Code (I.R.C.) § 172, part of the tentative refunds issued in
the five cases should have been recaptured (“clawed back”). The examiner did not always take
the steps to recapture the tentative refund issued to the taxpayer based on the Form 1139.
Figure 6 presents a hypothetical example to illustrate how examination NOL adjustments affect
NOL carrybacks and impact tentative refunds issued.
Figure 6: Illustration of How NOL Examination
Adjustments Affect Form 1139 Tentative Refunds Issued
Taxpayer Reported NOL Amount on TY 2018 Filed Form 1120 $(1,000,000)
IRS Examination Adjustment on the NOL $300,000
Adjusted NOL Available Per IRS Examination $(700,000)
Impact of Examination NOL Adjustments on Form 1139 Tentative Refunds Issued
TY 2013 TY 2014
Return Examination Return Examination
Taxable Income Per Filed Return $800,000 $800,000 $200,000 $200,000
Tax Per Return Filed $272,000 N/A $61,250 N/A
Apply NOL Available From TY 2018 $800,000 $700,000 $200,000 $0
Taxable Income After Applying NOL Carryback $0 $100,000 $0 $200,000
Processed Form 1139 (Refund to Taxpayer) $272,000 N/A $61,250 N/A
Adjusted Tax Per Examination $0 $22,250 $0 $61,250
Excess Refund Per Examination N/A $22,250 N/A $61,250
Source: TIGTA-created example.
As noted in Figure 6, the impact of the examination of TY 2018 would result in the recapture of
tax of $22,250 for TY 2013 and $61,250 for TY 2014 as a consequence of the reduced NOL
available from TY 2018. This process would require the examiner to pick up TYs 2013 and 2014
and consider the processed Form 1139 refund issued with respect to the reduced NOL for
TY 2018 from the examination.
However, in some instances when the examiner completed the Form 4549, Report of Income Tax
Examination Changes, the examiner did not consider the impact of the reduced NOL, and the
tax computations did not incorporate refunds already issued based on Forms 1139 filed as
NOLs.
Based on our results, the SB/SE Division re-reviewed these cases and researched the taxpayers’
accounts. As of April 2022, the SB/SE Division was working to identify the appropriate steps
necessary to recover (“claw back”) the excess tentative refunds issued.
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
LB&I Division examinations
We also reviewed all nine Form 1120 examinations closed in FYs 2020 and 2021 (see Figure 5).
Six cases were closed as no change, and the resolution for the remaining three cases were
handled appropriately.
Management Actions
Even though there was not a significant number of closed examination cases for TIGTA to review
at the time of our audit, what we found with the SB/SE Division examinations indicated a
weakness that needed to be addressed in order to protect the Government’s revenue.
We shared our results of SB/SE Division examinations with IRS management. They concurred
and took timely corrective actions. On February 7, 2022, the IRS issued interim guidance to
SB/SE and LB&I Divisions’ examination operations. The memorandum provided guidance on
steps to take when examining tax returns reporting a NOL. To help ensure that all actions taken
by the taxpayer are considered during the examination, the procedures include requiring
examiners to ask the taxpayer if the loss was carried back. Additionally, the examiner must
review the taxpayer’s account at the beginning of the examination and again during the
preparation of the proposed tax adjustment report for all eligible carryback years in search of
indications the loss was carried back. According to the IRS, the procedure changes will
ultimately be incorporated into the Internal Revenue Manual.
Furthermore, to immediately raise examiners’ awareness of the examination procedures outlined
in the interim guidance, IRS management took the following supplementary actions to help
ensure that examiners understand their responsibilities for and are addressing the impact of any
NOL carrybacks in their examinations:
• On February 10, 2022, the SB/SE Division requested all its Examination Directors (Field,
Campus, and Special) distribute the interim guidance throughout their organizations.
Also, the SB/SE Division’s Examination Quality and Technical Support group submitted an
article for inclusion in the next quarterly Technical Digest publication.
• On February 14, 2022, the LB&I Divisions included an article in its weekly newsletter
LB&I Frontline. This publication is distributed to all LB&I Division frontline employees.
Recommendation 3: The Commissioner, SB/SE Division should review the examination results
and computations of proposed NOL adjustments for the 25 “still open” Form 1120 examinations
with associated Forms 1139, as referenced in Figure 4, excluding Joint Committee Refund cases
which currently have specific review requirements in place, to determine if the interim guidance
regarding NOLs is being properly followed.
Management’s Response: IRS management agreed with the recommendation and will
review the examination results and computations of the 25 “still open” examinations for
a maximum period of 18 months to evaluate if the procedures identified in the interim
guidance memorandum, dated February 7, 2022, are being properly followed. IRS will
take action to address deviations, as necessary.
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That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Appendix I
Detailed Objective, Scope, and Methodology
The overall objective of this audit was to assess the IRS’s efforts to ensure corporate taxpayers
compliance with NOL provisions pertaining to Form 1139 tentative refunds application under
the CARES Act. To accomplish our objective, we:
• Obtained information from the IRS regarding controls in place to ensure the NOL
amounts claimed on Form 1139 are accurate and that the claimed decrease in taxes for
carryback years are valid.
• Assessed the Forms 1139 received and the IRS’s examination coverage of those
Forms 1139. To accomplish this, we:
1. Obtained from the Wage and Investment Division a data extract of Forms 1139
received on or after March 27, 2020, through March 31, 2021, that involved a
carryback.
2. Obtained from the LB&I and SB/SE Divisions a data extract of Forms 1120 selected
on or after March 27, 2020, for examination.
3. Determined the number of Forms 1120 selected for examination that involve a “loss”
year claimed on Form 1139 by comparing the Form 1139 and Form 1120 data
extracts from Steps 1 and 2.
4. Reviewed the IRS’s closed examinations on Forms 1120 that involve a “loss” year
claimed on the Form 1139.
• Determined the tentative refunds that the IRS issued as a result of Forms 1139 received
on or after March 27, 2020, through March 31, 2021. We estimated the tentative refund
amounts by matching the taxpayers in the Form 1139 data extract with the IRS’s Business
Master File tax adjustment data (Transaction Codes 295 and 294) through May 27, 2021.
Performance of This Review
This review was performed with information obtained from Wage and Investment, SB/SE, and
LB&I Divisions during the period May 2021 through April 2022. We conducted this performance
audit in accordance with generally accepted government auditing standards. Those standards
require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide
a reasonable basis for our findings and conclusions based on our audit objective. We believe
that the evidence obtained provides a reasonable basis for our findings and conclusions based
on our audit objective.
Major contributors to the report were Matthew A. Weir, Assistant Inspector General for Audit
(Compliance and Enforcement Operations); Christina Dreyer, Director; Timothy Greiner, Director;
Lee Hoyt, Audit Manager; and Julia Tai, Lead Auditor.
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Validity and Reliability of Data From Computer-Based Systems
We performed tests to assess the reliability of data extracts provided by the IRS. We assessed
the accuracy of the Form 1139 data extract by verifying 28 records against the IRS’s
Correspondence Imaging System. Additionally, we assessed the accuracy of LB&I and SB/SE
Divisions’ Form 1120 data extract by verifying 14 and 13 records, respectively, against the IRS’s
Integrated Data Retrieval System. Furthermore, we assessed the accuracy of the Business Master
File tax adjustment data by verifying 32 records against the IRS’s Integrated Data Retrieval
System. We determined that the data were sufficiently reliable for purposes of this report.
Internal Controls Methodology
Internal controls relate to management’s plans, methods, and procedures used to meet their
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance. We determined that the
following internal controls were relevant to our audit objective: the process in place for
reviewing tentative refund applications and Form 1139 filing consideration in the examination
process. We evaluated these controls by interviewing representatives and obtaining information
from Wage and Investment Division Accounts Management regarding Form 1139 processing,
reviewing IRS procedures, obtaining information from the LB&I and SB/SE Divisions regarding
Form 1120 selection for examination, and reviewing closed examination cases that had a
Form 1139.
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Appendix II
Form 1139, Corporation Application for Tentative Refund
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Appendix III
Management’s Response to the Draft Report
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Page 17
Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Appendix IV
Glossary of Terms
Term Definition
A computer system used by IRS Examination functions to control returns,
Audit Information
input assessments/adjustments to the Master File, and provide
Management System
management reports.
The IRS database that consists of Federal tax-related transactions and
Business Master File accounts for businesses. These include employment taxes, income taxes on
businesses, and excise taxes.
A corporation that is taxed separately from its owners. The profit of a
C Corporation C corporation is taxed to the corporation when earned and distributed to
shareholders as dividends.
A system that captures images of correspondence from taxpayers intended
Correspondence Imaging for IRS Accounts Management employees. Correspondence includes
System letters, returned notices, and standard forms which were scanned and
electronically routed to Accounts Management employees.
Any yearly accounting period, regardless of its relationship to a calendar
Fiscal Year year. The Federal Government’s fiscal year begins on October 1 and ends
on September 30.
Integrated Data The IRS computer system capable of retrieving or updating stored
Retrieval System information. It works in conjunction with a taxpayer’s account records.
The primary, official source of IRS instructions to staff related to the
Internal Revenue Manual
organization, administration, and operation of the IRS.
The term “net operating loss” means the excess of the allowable
Net Operating Loss deductions (computed with the modifications specified in I.R.C. § 172(d))
over gross income.
A 12-month accounting period for keeping records on income and
Tax Year expenses used as the basis for calculating the annual taxes due. For most
individual taxpayers, the tax year is synonymous with the calendar year.
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Compliance Efforts Are Needed to Address Refund Claims Reported on Form 1139
That Are Based on the CARES Act Net Operating Loss Carryback Provisions
Appendix V
Abbreviations
CARES Coronavirus Aid, Relief, and Economic Security
FY Fiscal Year
I.R.C. Internal Revenue Code
IRS Internal Revenue Service
LB&I Large Business and International
NOL Net Operating Loss
SB/SE Small Business/Self-Employed
TCJA Tax Cuts and Jobs Act
TIGTA Treasury Inspector General for Tax Administration
TY Tax Year
Page 20
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