Tax Options to Relieve Dried-up Cashflow

Many companies are experiencing record losses due to a sluggish economy worsened by the September 11 terrorist attacks. Compounding matters, some of these companies have a tax liability payable at this time. Corporations have several tax planning options that they can use to generate much-needed cash.

Quick Refunds

Under Sec. 6425(a), a corporation can file Form 4466, Corporation Application to Quick Refund of Overpayment for Estimated Tax, to adjust an estimated-tax overpayment, rather than waiting to file for a refund on Form 1120. A taxpayer has to meet the following requirements to file Form 4466:

• It has to file Form 4466 before filing Form 1120;
• It has to file Form 4466 after the end of the corporate tax year, but before the 16th day of the third month after the end of the tax year; and
• The quick refund of the overpayment on the estimated tax has to be at least 10% of the expected tax liability and at least $500. Within 45 days, the IRS will issue the requested refund for a materially correct Form 4466.

Example 1: Due to recently declining sales, corporation XYZ adjusted its expected tax liability to $200,000 for the year ending Dec. 31, 2001. Throughout the tax year, XYZ had made estimated tax payments totaling $300,000. It also has an overpayment credit of $25,000 from the prior tax year. XYZ decides to file for a quick refund of the $125,000 between Jan. 1, 2001 and March 15, 2001, rather than waiting to file for the refund on its year-end return, which it expects to file after March 15, 2001.

Corporations applying for quick refunds should consider the safe-harbor rules. An excessive refund (as defined in Sec. 6655(h)) would trigger underpayment penalties. In general, a corporation has to make four timely estimated tax installments, equal to 25% of the smaller of the current-year or prior-year tax liability. However, a "large corporation" (defined as a corporation with taxable income of at least $1 million dollars in any of the three preceding tax years) has to pay estimated tax equal to the current tax liability. Members of a control group (as defined in Sec. 1563) have to divide the $1 million among themselves. A large corporation can only base the first installment on the prior-year tax liability. It has to pay any deficiency with the second installment. A corporation cannot include net operating losses (NOLs) or capital loss carrybacks or carryovers when computing its taxable income.

Extensions and Penalties

Under Sec. 6164, a corporation can use Form 1138, Extension of Time for Payment of Taxes by a Corporation, to carry back an expected current-year NOL to the tax year immediately preceding the current year, to extend the time it has to pay tax. The corporation has to meet the following requirements to file Form 1138:

• Wait until the beginning of the current tax year of the expected NOL to file Form 1138; and
• Only postpone payment of a tax liability not yet paid or due.

The extension date for paying the postponed tax liability expires at the end of the month following the tax return filing date (including extensions) of the NOL tax year. To extend that date further, a corporation can File Form 1139, Corporation Application for Tentative Refund, as long as it does so before the end of the extension date.

A corporation incurs interest when it postpones payment of a tax liability, from the time payment was originally due until the date the corporation pays it. Generally, interest accrues at the Federal short-term rate plus three percent, as specified in Sec. 6621(a)(2).

The corporation may increase the NOL carryback to cover interest charges incurred on postponing the payment of a tax liability.

If, after filing Form 1138, the expected NOL changes, the corporation can file a revised Form 1138. It has to pay any additional tax liability that may result from a decrease in the expected NOL.

Example 2: Corporation XYZ had a record profit for calendar-year 2001. As a result, it incurred a $400,000 tax liability for the tax year ending Dec. 31, 2001. Based on a prior-year safe-harbor tax liability of $200,000, XYZ made timely estimated quarterly tax installment payments of $50,000 for 2001. Due to a sharp drop in projected sales revenue for 2002, XYZ expects to incur a large NOL. After realizing the expected NOL, XYZ plans to carry back the NOL to 2001 and generate a tax savings of $150,000. On March 15, 2002, XYZ decides to file Form 7004, Application for Automatic Extension of Time to File Corporation Income Tax Return, and pay $50,000 with the extension. In addition, along with Form 7004, it files Form 1138, extending the time to pay the remaining $150,000 tax liability. If a taxpayer does not file Form 1138 by March 15, 2002, the $150,000 is a required payment. After March 15, 2002, the corporation cannot file Form 1138.

In Example 2, interest would start to accrue as of March 15, 2002, until XYZ:

• Pays the $150,000 tax liability: If XYZ does not file Form 1139 before September 30, it would pay interest until Sept. 30, 2002, when the tax liability plus the interest would be due.
• Files Form 1139 before Sept. 30, 2002: If XYZ files Form 1139 by that date, interest would be due up until the date the IRS either allows or disallows the application for tentative refund in whole or in part.

In Example 2, if XYZ had an NOL tax savings in excess of its tax liability, it might have to increase the NOL carryback to cover interest charges accrued on postponing payment of the liability.

Further, if XYZ were a large corporation, it would not be eligible to file Form 1138 unless it annualized income. In general, a large corporation has to pay 100% of its current tax liability in four installments. Underpayments of estimated tax for a large corporation are required payments. Required payments are considered paid for purposes of filing Form 1138. However, a seasonal business that is a large corporation can annualize its installments; under the standard method, the fourth-quarter installment is computed using the first nine months of taxable income. The excess tax liability generated in the fourth quarter is due when the corporation files its Federal return or extension, unless it postpones payment by filing Form 1138.

In a final analysis, a corporation can postpone tax payments that would "normally" be due on a return's nonextended filing date. Tax liabilities "normally" due exclude delinquent installment payments as prescribed by the safe-harbor rules.

NOL Carrybacks

According to Sec. 172(b), a corporation can carry back an NOL to each of the two tax years preceding the NOL year, and forward to each of the 20 tax years following the NOL year. A corporation can also file Form 1139 to carry back an NOL, not just to apply for a tax refund. Generally, a corporation has to carry back the NOL two years before the NOL year. It carries any remaining NOL to the year preceding the NOL year. The corporation can also use Form 1139 to carry back a net capital loss or unused general business credit. A corporation has to meet the following requirements to file Form 1139:

• File the current-year Form 1120 on or before the date it files Form 1139;
• File Form 1139 separately; and
• Not attach a statement to a loss-year return electing to relinquish the carryback.

The corporation has to file Form 1139 within one year of the end of the loss tax-year to carry back an NOL to a profit year. If it goes past one year, the corporation could carry back the NOL by amending its original Form 1120. Generally, the corporation has to file Form 1120X within three years of the original tax return due date (or date filed, if later).

Generally, the IRS will process Form 1139 within 90 days of the last day of month of the corporation's tax-filing due date (or extended due date) or, if later, within 90 days of the date the corporation filed Form 1139. However, under Sec. 6405(a), the corporation must submit an application for a refund in excess of $2 million (increased from $1 million by the Tax Relief Act of 2000) to the Joint Committee for review. Refunds of this size are not issued to the corporation until 30 days after the IRS submits a report to the committee.

If a corporation had taxable income in the second year before the tax loss year, it has to use the NOL carryback for that year to pay postponed tax liabilities (using Form 1138). The IRS may subsequently refund the remaining tax savings generated by the NOL carryback to both tax profit years.

Example 3: Corporation XYZ made a profit in calendar years 2000 and 2001. It incurred a $400,000 tax liability in 2001 and a $200,000 liability in 2000. Based on a prior-year safe-harbor tax liability of $200,000, in 2001, XYZ made timely estimated quarterly tax installment payments of $50,000 each. Due to a sharp drop in 2002 projected sales revenue, XYZ expects to incur a large current-year NOL that will generate a $350,000 tax savings if it carries back the NOL. On March 15, 2002, XYZ decides to file Form 7004. In addition, it files Form 1138 with Form 7004, extending the time to pay the remaining $200,000 for the Dec. 31, 2001 tax liability.

After realizing the projected NOL in 2002, XYZ files Form 1120 on Sept. 15, 2003. Subsequently, on Sept. 30, 2003, it files Form 1139 to apply as a credit the $200,000 2000 tentative refund and $10,000 of the 2001 tentative refund to pay the $200,000 2001 postponed tax liability, plus accrued interest. XYZ incurs $10,000 in interest on the postponed tax liability, from March 15, 2002 until the date the IRS accepted Form 1139. It carries back the remaining 2002 NOL to 2001 for a tentative refund of $140,000. The IRS approves Form 1139 by Dec. 31, 2003.

Summary

A private corporation with an immediate need for cash should consider preparing Forms 1120 and 1139 at the end of the tax year with conservative pre-audit numbers. The Service processes Form 1139 and issues a refund within 90 days of the Form 1120 due date. The corporation can subsequently file amended tax returns to adjust any discrepancies from final audited financial statements.

From Keith Montante, Melville, NY