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Part 4. Examining Process

Chapter 61. LMSB International Program Audit Guidelines

Section 13. Dual Consolidated Losses

4.61.13  Dual Consolidated Losses

4.61.13.1  (03-27-2009)
Introduction

  1. The dual consolidated loss ("DCL" ) provisions of the Internal Revenue Code ("IRC" ) and regulations are intended to prevent an entity from using a loss to offset income of a domestic affiliate in the United States while using the same loss to offset income of a foreign affiliate which is not subject to U.S. tax. The DCL provisions are intended to prevent the "double dipping" of a single loss.

    Example 1 USP, a United States corporation, files a United States consolidated return with its domestic subsidiary, USSub. USP is managed and controlled in foreign country FC and is considered under the tax laws of FC to be a resident of FC. USP is taxed on its worldwide income under the tax laws of FC. Under the tax laws of FC, USP files a consolidated return in FC with its Country FC subsidiary, FSub. In year 1, USP incurs a net operating loss which it uses to (1) offset income of USSub on its U.S. consolidated return and (2) offset income of FSub on its FC consolidated return. Here, USP has "double dipped" a single economic loss.

  2. The regulations promulgated under section 1503(d) provide the operating rules for DCLs. See Treas. Reg. 1.1503(d)-1 et. seq.

  3. The purpose of this IRM section is to provide practical guidance to IRS personnel in identifying DCLs and developing selected issues under the DCL rules. The guidance includes:

    • Suggested examination techniques to identify dual resident corporations, separate units and DCLs.

    • Suggested examination techniques to develop prevalent DCL issues including the application of the mirror legislation rule and the recognition and treatment of triggering events.

    • Explanation of how to compute the amount of recapture upon the occurrence of a triggering event and the corresponding interest charge.

    • Suggested administrative procedures for processing and developing a request for reasonable cause pursuant to Treas. Reg. 1.503(d)-1(c).

  4. IRS personnel should have at least a basic understanding of the substantive DCL rules in order to effectively use this IRM section. This IRM section is not intended as an exhaustive explanation of the substantive DCL rules. For guidance on the substantive DCL rules please refer to the Dual Consolidated Losses Industry Program webpage at: http://lmsb.irs.gov/hq/pftg/irc1503 .

4.61.13.2  (03-27-2009)
Examination Techniques

  1. This sub-section provides suggested examination techniques for examining selected prevalent DCL issues.

4.61.13.2.1  (03-27-2009)
Preliminary Analysis

  1. In the early stages of the examination, IRS personnel should identify any entity which is a dual resident corporation (DRC) or a separate unit (including an interest in a hybrid entity separate unit) and whether any of these entities incurred a DCL.

4.61.13.2.1.1  (03-27-2009)
Organizational Chart of Worldwide Operations

  1. Understanding the taxpayer’s organizational structure is critical to determining the existence of DCLs. As a preliminary matter, IRS personnel should secure a complete organizational chart of the taxpayer’s worldwide operations.

  2. Beginning with the first day of the first tax year under examination, IRS personnel should secure an organizational chart which reflects the following information for each entity worldwide:

    1. Classification of the entity for U.S. tax purposes (egs. non-hybrid corporation, non-hybrid partnership, disregarded entity, branch (or permanent establishment), hybrid partnership, or reverse hybrid entity);

    2. Classification of the entity for foreign purposes;

    3. Ownership interest(s) in the entity, including the identity of each owner and the amount of each owner’s respective interest;

    4. Whether the entity is considered domestic or foreign for U.S. tax purposes; and

    5. Legal name of the entity.

      Note:

      The organizational chart should include branches (or permanent establishments under an applicable tax treaty) of any entities.

  3. The generally recognized symbols for the entities include:

    Figure 4.61.13-1

    This image is too large to be displayed in the current screen. Please click the link to view the image.

  4. Any changes to the organizational chart which occur during tax years under examination should be tracked in chronological order and the chart should be updated to reflect the changes. Changes may include:

    1. Change in entity classification (e.g. "check-the-box" election);

    2. Merger or reorganization; or

    3. Change in ownership of an entity.

  5. IRS personnel should take the following steps to secure a complete and accurate organizational chart of the worldwide operations of the taxpayer:

    1. Request an organizational chart reflecting the information set forth in IRM 4.61.13.2.1.1(2) (a)-(e) with changes tracked chronologically;

    2. Review Form 1120, Schedule N, "Foreign Operations of U.S. Corporations" ;

    3. Review each Form 5471, "Information Return of U.S. Persons With Respect to Certain Foreign Corporations" , filed with the return;

    4. Review each Form 8832, "Entity Classification Election" , attached to the return;

    5. Review each Form 8858, "Information Return of U.S. Persons With Respect to Disregarded Entities" , filed with the return;

    6. Review each Form 8865, "Return of U.S. Persons With Respect to Certain Foreign Partnerships" , filed with the return;

    7. Request that the taxpayer confirm that no other Form 8832, Form 8858 or Form 8865 should have been filed but was not filed. If the taxpayer cannot confirm this, request an explanation;

    8. Discuss with the taxpayer any discrepancies between the chart furnished by the taxpayer and your findings from reviewing the tax returns; and

4.61.13.2.2  (03-27-2009)
Determining the Existence of DRCs and Separate Units

  1. Based on the organizational chart of the taxpayer, IRS personnel can generally determine whether the taxpayer has any dual resident corporations (DRCs) or separate units. See IRM 4.61.13.2.1.1. for details on the creation of the organizational chart.

  2. The following may indicate that an entity is a separate unit:

    1. Form 8858 filed by a domestic corporation.

    2. Form 8865 filed for an interest in a" hybrid entity partnership" owned, directly or indirectly, by a domestic corporation.

      Note:

      An interest in a "non-hybrid entity partnership" is not a separate unit. However, a separate unit (egs. foreign branch, hybrid entity separate unit) may be owned indirectly through a non-hybrid partnership.

      Note:

      If line G7 of the Form 8865 (rev. 2007) indicates that the partnership is organized as a corporation in the foreign country, the partnership may be a "hybrid entity partnership" .

    3. If line G8 of the Form 8865 (rev. 2007) is answered in the affirmative by a domestic corporation, the domestic corporation indirectly owns separate unit(s).

    4. If line G6 of a Form 8865 (rev. 2007) filed by a domestic corporation lists Form(s) 8858, the domestic corporation indirectly owns separate unit(s).

  3. If two or more individual separate units are owned by a domestic owner or two or more domestic owners that are members of the same consolidated group and the individual separate units are located or subject to tax in the same foreign country, then such individual separate units shall be treated as one separate unit (a "combined separate unit" ). This separate unit combination rule is mandatory and not elective. See Treas. Reg. 1.1503(d)-1(b)(4)(ii) for further details.

  4. The IRS personnel should review the prior international examiner's audit reports for potential leads on identifying DRCs or separate units and/or DCLs claimed in prior years that may have an impact on the current examination.

4.61.13.2.3  (03-27-2009)
Determining the Existence of a DCL

  1. Generally the loss of a DRC or a separate unit (or an interest in a hybrid entity separate unit) is a DCL.

4.61.13.2.3.1  (03-27-2009)
Techniques for Determining the Existence of a DCL

  1. A domestic use election filed with the tax return establishes that the entity for which the election is made is a DRC or separate unit (or the taxpayer has an interest in a separate unit) that has a DCL.

  2. The following may indicate that a separate unit has a DCL.

    1. An affirmative answer to Form 8858 (rev. Dec. 2007), Schedule G, Question 4 indicates that the separate unit has a DCL.

    2. Form 8858 (rev. Dec. 2007) at Schedule H, Line 7 reflects a current negative earnings and profits in U.S. dollars.

    3. The income statement of the DRC or separate unit reflects a loss for the year.

      Note:

      The income statement of the DRC or separate unit may be based upon foreign GAAP and not necessarily reflect the amount of income or loss for DCL purposes.

  3. If the taxpayer files with a U.S. income tax return a statement entitled "No Possibility of Foreign Use of Dual Consolidated Loss Statement" IRS personnel should scrutinize this statement because it means the taxpayer acknowledges that the loss at issue on the statement is a DCL but the taxpayer is submitting that the loss should not be subject to the DCL rules. See IRM 4.61.13.2.4.2.

4.61.13.2.4  (03-27-2009)
Examination of DCL in the Year of Loss

  1. If a DRC or separate unit exists and that DRC or separate unit incurs a loss which is a DCL in the tax year, the general rule is that the DCL may not be used to offset the income of any domestic affiliate on the U.S. return in that tax year or any other tax year.

  2. However, there are exceptions to the general rule.

    • See IRM 4.61.13.2.4.1.for domestic use elections.

    • See IRM 4.61.13.2.4.2. for no possibility of foreign use

  3. If the taxpayer uses a DCL to offset income of a domestic affiliate in the year the loss is incurred, IRS Personnel should determine whether the taxpayer was able to do so and appropriately did so.

    Note:

    IRS personnel should cross-check any timely filed domestic use elections to the DRC or separate unit that filed the domestic use election. Any DRC or separate unit that has a loss without a corresponding domestic use election should be examined to ensure that an improper use of such loss has not occurred.

4.61.13.2.4.1  (03-27-2009)
Domestic Use Election

  1. The taxpayer may use a DCL to offset income of a domestic affiliate if the taxpayer files a domestic use election for the particular DCL incurred by the particular DRC or separate unit. Treas. Reg. 1.1503(d)-6(d).

  2. IRS Personnel should compare the amount of DCL claimed on the domestic use election with the amount of loss of the DRC or separate unit. IRS Personnel should discuss any disparity with the taxpayer.

  3. IRS Personnel should determine whether there was a foreign use of the DCL in the year it was incurred. IRS Personnel may review the foreign income tax returns to determine this. If there has been a foreign use, the taxpayer may not file a domestic use election for the DCL and the DCL is basically subject to the SRLY ("Separate Return Limitation Year" ) rules.

    Note:

    The use of the DCL to offset income attributable to the DRC or separate unit itself is generally not considered a foreign use. See Treas. Reg. 1.1503(d)-4(c)(3).

4.61.13.2.4.1.1  (03-27-2009)
Mirror Legislation

  1. The DCL regulations provide a specific mirror legislation rule which may prohibit a taxpayer from filing a domestic use election agreement for an otherwise eligible DCL. Treas. Reg. 1.1503(d)-3(e)

  2. Under the mirror legislation rule, if the foreign country has its own DCL rule which "mirrors" that of the United States and that foreign country's DCL rule applies to the loss at issue, then for purposes of the U.S. DCL rules a foreign use of the DCL will be deemed to occur. Therefore, since there is deemed to be a foreign use of the DCL, the taxpayer cannot file a domestic use election for the loss. As a result, the taxpayer may not utilize this loss to offset a domestic affiliate’s income for U.S. tax purposes and the DCL is subject to the domestic use limitation rule which requires such loss to be treated as a SRLY loss.

    Note:

    Under a "stand alone exception" , the mirror legislation rule does not apply where there is no affiliate to which the loss can be surrendered. Treas. Reg. 1.1503(d)-3(e)(2).

  3. Currently, the United Kingdom, Australia, New Zealand and Germany have some form of mirror legislation.

  4. The mere existence of mirror legislation in the foreign country does not by itself make the mirror legislation rule applicable to every DRC or separate unit in that country. Rather, the mirror legislation rule only applies if the mirror legislation in the foreign country applies to the specific DRC (or separate unit) and DCL at issue.

4.61.13.2.4.1.1.1  (03-27-2009)
Elective Agreement Between U.S. and Foreign Country

  1. The mirror legislation rule does not apply if there is an elective agreement between the U.S. and the foreign country pursuant to Treas. Reg. 1.1503(d)-6(b) which applies to the specific DRC (or separate unit) and the DCL at issue.

    Note:

    The U.S. has entered into one elective agreement. On October 6, 2006, the U.S. and the United Kingdom entered an elective agreement which provides that a taxpayer may elect to use the DCL of a U.K. permanent establishment to offset income of a U.S. affiliate notwithstanding mirror legislation which would otherwise be applicable to losses incurred by the permanent establishment. United Kingdom/United States Dual Consolidated Loss Competent Authority Agreement , Announcement 2006-86, 2006-45 I.R.B. 842. The U.S. - U.K. agreement does not apply to losses incurred by DRCs or hybrid entity separate units.

4.61.13.2.4.2  (03-27-2009)
No Possibility of Foreign Use

  1. The DCL regulations provide an exception to the general rule prohibiting the domestic use of a DCL. To qualify for the exception, the taxpayer must demonstrate to the satisfaction of the Service that there can be no foreign use of the DCL at any time by any means. Treas. Reg. 1.1503(d)-6(c). The IRS generally considers this exception to entail a difficult burden for the taxpayer and will apply only in rare and unusual situations.

  2. The taxpayer makes the claim by attaching a statement entitled "No Possibility of Foreign Use of Dual Consolidated Loss Statement" to a timely filed return for the taxable year in which the DCL is incurred.

  3. IRS Personnel should scrutinize any "No Possibility of Foreign Use Statement" . By filing a "No Possibility of Foreign Use Statement" , the taxpayer is acknowledging that the loss at issue is a DCL but nevertheless should not be subject to the DCL rules.

  4. The taxpayer must submit a detailed analysis of the foreign law in support of its "No Possibility of Foreign Use Statement" . See Treas. Reg. 1.1503(d)-6(c)(2).

  5. If assistance is required in analyzing the taxpayer’s "No Possibility of Foreign Use Statement" , IRS Personnel should initially contact local Area Counsel.

  6. If available and as necessary, IRS Personnel may consider contacting a tax attaché of the foreign country to request assistance with understanding the foreign country’s law.

  7. As necessary, IRS Personnel may consider procuring outside expert(s) to assist in understanding the foreign law and analyzing the taxpayer’s analysis of the foreign law.

4.61.13.3  (03-27-2009)
Disallowance of a DCL

  1. If the taxpayer has not properly filed, or is prohibited from filing, a domestic use election for a particular DCL and has not properly demonstrated that there is no possibility of a foreign use, IRS Personnel should disallow any use of the DCL to offset domestic affiliate income and propose adjustments as appropriate. See IRM 4.61.13.6.1.

4.61.13.4  (03-27-2009)
Examination of Tax Years Following the Year of the DCL

  1. If the taxpayer incurs a DCL in a given taxable year and the taxpayer files a domestic use election for that DCL, IRS Personnel should be aware that events in subsequent taxable years may affect the tax treatment of the DCL.

    Note:

    For example, failure to timely file the required annual certification is deemed a triggering event that requires the recapture of the DCL amount. Be aware that taxpayer may request reasonable cause relief from such failure. See IRM 4.61.13.7. for guidance on requests for reasonable cause relief.

  2. See IRM 4.61.13.4.2. for triggering events (including the failure to file an annual certification). See IRM 4.61.13.5. for recapture of a DCL.

4.61.13.4.1  (03-27-2009)
Annual Certifications

  1. If the taxpayer files a domestic use election for a DCL, the taxpayer must file an annual certification in each of the subsequent five taxable years ("certification period" ). During the certification period, the taxpayer is prohibited from making a foreign use of the DCL.

    Note:

    Under the prior version of the DCL regulations, the equivalent of the domestic use election was the so-called "(g)(2) election" . Treas. Reg. 1.1503-2(g)(2). Any reference in this IRM section made to a domestic use election, including the accompanying annual certification, can generally be considered as made to a (g)(2) election.

  2. If the taxpayer fails to file an annual certification, the taxpayer generally must recapture into income the amount of the DCL covered by the domestic use election to which the annual certification relates. The failure to file an annual certification is a "triggering event" . See IRM 4.61.13.4.2. for triggering events (including the failure to file an annual certification). See IRM 4.61.13.5. for recapture of a DCL.

    Note:

    A taxpayer may seek to remedy a failure to timely file an annual certification by requesting reasonable cause relief pursuant to Treas Reg. 1.1503(d)-1(c). See IRM 4.61.13.7.

  3. On audit, IRS Personnel should review the income tax returns for the taxable years under audit and, if feasible, the five prior taxable years in order to:

    1. track each domestic use election that has been filed (including any domestic use election filed during the five taxable years prior to a taxable year under audit) since the domestic use election will necessarily require the taxpayer to file annual certifications during the certification period;

    2. determine whether annual certifications have been properly filed for any DCL subject to a domestic use election; and

    3. determine whether there has been a foreign use of the DCL subject to the domestic use election during the certification period.

      Note:

      To determine whether there has been a foreign use of the DCL may require a review of foreign income tax returns and/or changes in the taxpayer's organizational chart.

  4. Review prior cycle international examiner's reports and/or planning files to identify any domestic use elections that require annual certifications to be included with the return(s) for tax years currently under examination.

4.61.13.4.2  (03-27-2009)
Triggering Events

  1. The DCL regulations provide that upon the occurrence of certain events, the taxpayer may be required to recapture into income some or all of a DCL subject to a domestic use election. These events are called "triggering events" .

    Note:

    Triggering events are only relevant and considered if the taxpayer has a timely filed and valid domestic use election for a DCL.

  2. Treas. Reg. 1.1503(d)-6(e) provides a list of triggering events. Possible triggering events include, but are not limited to:

    1. A foreign use of the DCL, (including a deemed use pursuant to the mirror legislation rule under Treas. Reg. 1.1503(d)-3(e)).

    2. Disaffiliation of the DRC or the domestic owner of a separate unit.

    3. Affiliation of an unaffiliated DRC or the domestic owner of a separate unit with a consolidated group.

    4. Conversion of certain entities to foreign corporations (e.g. a reorganization or a check-the-box election by a foreign disregarded entity).

    5. Failure to file an annual certification with respect to a DCL.

    6. Certain transfers of assets of the DRC or separate unit or an interest in a separate unit.

    7. Cessation of the stand-alone exception to the mirror legislation rule.

4.61.13.4.2.1  (03-27-2009)
Examination of Triggering Events

  1. With regard to triggering events, IRS Personnel should review the list of triggering events contained in the DCL regulations to determine whether a triggering event has occurred.

  2. The following events should be particularly scrutinized as potential triggering events:

    1. The use of losses by the DRC or separate unit to offset income other than income of the DRC or separate unit (or combined separate unit) under the income tax laws of the foreign country.

      Note:

      This may include reviewing foreign income tax returns to determine whether there has been a foreign use of the DCL during the certification period.

    2. The DRC or domestic owner of the separate unit either leaves a U.S. affiliated group or becomes a member of a new U.S. affiliated group.

    3. A transfer of assets of the DRC or separate unit.

    4. A transfer of an interest in the separate unit.

    5. A disregarded entity checks-the-box to become a foreign corporation.

    6. A DRC or separate unit subject to the stand-alone exception to the mirror legislation rule becomes affiliated under the laws of the foreign country.

      Note:

      To determine whether there has been a triggering event may require reviewing foreign income tax returns and/or the taxpayer's organizational chart.

  3. If during audit a triggering event, including a foreign use, is identified and the taxpayer failed to report the corresponding recapture amount on its income tax return for the year of the triggering event, a proposed audit adjustment will include the recapture of the entire amount of the DCL into income plus the interest charge.

    • See IRM 4.61.13.5. for the recapture of a DCL upon the occurrence of a triggering event.

    • See IRM 4.61.13.5.1. for the computation of the interest charge.

    • See IRM 4.61.13.5.4. for the computation of taxable income in the year of the DCL recapture.

    • See IRM 4.61.13.6.2. for guidance in report writing for the recapture of a DCL.

4.61.13.4.2.2  (03-27-2009)
Rebuttal of Triggering Events

  1. A taxpayer may rebut a triggering event by demonstrating that there can be no foreign use of the DCL (or no carryover of losses, deductions or expenses under foreign law if the triggering event involves transfer of 50% or more of the DRC or separate unit's assets) during the remaining portion of the certification period.

  2. In order to make the rebuttal the taxpayer must prepare and attach a statement labeled "Rebuttal of Triggering Event" to the taxpayer's timely filed income tax return for the taxable year in which the triggering event occurs.

  3. The taxpayer must submit a detailed analysis of the foreign law in support of its "Rebuttal of Triggering Event" .

  4. If assistance is required in analyzing the taxpayer’s "Rebuttal of Triggering Event" , IRS Personnel should initially contact local Area Counsel.

  5. If available and as necessary, IRS Personnel may consider contacting a tax attaché of the foreign country to request assistance with understanding the foreign country’s law.

  6. As necessary, IRS Personnel may consider procuring outside expert(s) to assist in understanding the foreign law and analyzing the taxpayer’s analysis of the foreign law.

4.61.13.4.2.3  (03-27-2009)
Triggering Event Exceptions

  1. The DCL regulations list certain events that do not constitute triggering events and do not require the recapture of the DCL.

  2. Many of the events listed that do not constitute triggering events can generally be categorized into two groups:

    1. Events that will not constitute triggering events without the requirement of additional filings. See Treas. Reg. 1.1503(d)-6(f)(1).

      Note:

      These events typically involve the DRC or domestic owner remaining in the same consolidated group or the assets of the DRC or domestic owner remaining in the same consolidated group or with the same unaffiliated DRC or domestic owner after the event.

    2. Events that will not constitute triggering events only if a new domestic use election is filed by a subsequent elector and in some events, a statement is filed by the original elector. See Treas Reg. 1.1503(d)-6(f)(2).

      Note:

      These events typically involve transfers of the DRC or domestic owner or the assets of the DRC or domestic owner to a new or different domestic corporation or consolidated group.

  3. Treas. Reg. 1.1503(d)-6(f)(3) through (5) provide other triggering event exceptions in addition to those described in (2)(a) and (b) above.

  4. If the taxpayer takes the position that a triggering event exception applies, IRS Personnel should:

    1. Obtain from the taxpayer a complete factual basis and legal analysis for the exception.

    2. Confirm that any additional filings which were required for the event to be considered an exception were timely and properly filed. This may include confirming that a filing was made by another taxpayer (the "subsequent elector" ).

4.61.13.4.2.4  (03-27-2009)
Certification Period

  1. A taxpayer that makes a domestic use election must file an annual certification for the five taxable years following the year in which the DCL that is subject to the domestic use election was incurred. For each taxable year under audit in the certification period, IRS personnel should:

    1. Review the income tax return to determine if the annual certification has been filed.

    2. Analyze the taxpayer's facts to determine if any triggering events (including the failure to file the annual certification) have occurred. See IRM 4.61.13.4.2. for triggering events.

    3. Review the foreign tax returns to determine if there has been any foreign use (which is also a triggering event).

4.61.13.5  (03-27-2009)
Recapture of a DCL

  1. Upon the occurrence of a triggering event which applies to a DCL, generally the taxpayer must recapture the entire amount of the DCL. This is the "presumptive rule" in Treas. Reg. 1.1503(d)-6(h)(1)(i).

  2. The taxpayer recaptures the DCL as gross income on its income tax return for the taxable year in which the triggering event occurs.

    Note:

    The DCL is not treated as being recaptured in the taxable year the DCL was incurred for purposes of determining the " additional tax" which results from the recapture. The additional tax which results from the recapture of the DCL is determined in the taxable year the triggering event occurs.

  3. The taxpayer may rebut the presumptive rule of full recapture. See IRM 4.61.13.5.2.

  4. If the taxpayer reports a DCL recapture amount on the original return for the taxable year of the triggering event, IRS personnel should confirm that the taxpayer:

    1. Reported the recapture amount correctly. See IRM 4.61.13.5.2. if a rebuttal of the presumptive full recapture amount is filed.

    2. Computed taxable income correctly in that taxable year. See IRM 4.61.13.5.4.

4.61.13.5.1  (03-27-2009)
Interest Charge

  1. In connection with the DCL recapture, the taxpayer must pay an interest charge computed under IRC 6601(a).

  2. The interest charge is determined by treating the additional tax resulting from the DCL recapture for the year of triggering event as though the additional tax had been due and unpaid from the taxable year in which the DCL gave rise to a tax benefit. The taxable year in which the DCL gave rise to a tax benefit is typically the taxable year in which the DCL was incurred.

    • Normally for corporations, the additional tax owed as a result of the DCL recapture will equal the amount of the DCL recapture amount multiplied by the 35 percent corporate income tax rate.

    • For other taxpayers, the additional tax owned as a result of the DCL recapture will equal the amount of the DCL recapture amount multiplied by the taxpayer's applicable income tax rate.

    • A manual computation of the interest charge by IRS personnel will be necessary.

  3. The interest charge becomes a part of the tax liability for the taxable year of the triggering event and should be included as an identifiable "Miscellaneous Tax" on the examination report. See IRM 4.61.13.6.2.1. for guidance on report writing.

    Example. A corporation with a taxable year ending December 31, 2004 ("2004 tax year" ) properly filed a domestic use election with respect to a $10,000,000 DCL and used the full amount of the DCL to offset domestic affiliate income in the 2004 tax year. During the tax year ending December 31, 2006 ("2006 tax year" ), a triggering event occurred requiring the recapture of the DCL from the 2004 tax year. The taxpayer failed to report the DCL recapture in any amount on its income tax return for the 2006 tax year. Assuming that the applicable rate for this taxpayer on any additional tax assessment for the 2006 tax year is 35%, an audit adjustment may be made to include the full amount of the DCL ($10,000,000) in taxable income for the 2006 tax year. The additional tax assessment attributable to such recapture is $3,500,000 ($10,000,000 * .35). The interest charge is computed under section 6601(a) on the $3,500,000 amount for the period March 15, 2005 (the due date of the 2004 tax year return) through March 15, 2007 (the due date for the 2006 tax year return). The interest charge becomes part of the tax liability for the 2006 tax year. Assuming the interest charge is $100,000, the total tax liability resulting from the recapture is $3,600,000, i.e. $3,500,000 (the amount of the additional tax assessment from the recapture) plus $100,000 (the interest charge). Section 6601 applies to the tax liability if it is not paid timely.

  4. If the taxpayer reports the DCL recapture on the original return for the year of triggering event, confirm that the taxpayer paid the additional interest charge.

    1. The additional interest charge may be reflected on the front page of the return as a write-in amount.

    2. If the taxpayer properly reports the DCL recapture on its return for the year of the triggering event, but does not pay the interest charge, a Form 5701, Notice of Proposed Adjustment, should be issued for the interest charge. See IRM 4.61.13.6.3. below for the administrative procedures in addressing the interest charge in the audit report.

4.61.13.5.2  (03-27-2009)
Rebuttal of the Presumptive Rule of Full Recapture Amount

  1. The taxpayer may rebut the presumptive rule requiring recapture of the full amount of the DCL and thus reduce the recapture amount that must be included in income in the year of the triggering event.

  2. To rebut the presumptive amount of full recapture, the taxpayer must establish an amount by which the presumptive full amount of recapture is reduced (a "lesser amount" or "reduction of recapture amount" ).

  3. The "reduction of recapture amount" is an amount by which the DCL would have offset other taxable income reported on a timely filed U.S. income tax return for any taxable year up to and including the taxable year of the triggering event if no domestic use election had been made for the loss.

    Note:

    The reduction of recapture amount represents the amount of the DCL which the DRC or separate unit could have used to offset it own income under the SRLY rules, as modified by Treas. Reg. 1.1503(d).

    Note:

    For practical purposes, the reduction of recapture amount is the amount by which the presumptive full recapture amount is reduced.

  4. If the taxpayer establishes the reduction of recapture amount, the taxpayer will report as recapture income the full amount of recapture less the reduction of recapture amount.

  5. The taxpayer bears the burden of establishing the reduction of recapture amount.

    1. To satisfy its burden of establishing the reduction of recapture amount, the taxpayer must prepare a separate accounting labeled "Reduction of Recapture Amount" .

    2. The accounting must show the income for each year that would have offset the DRC or separate unit’s recapture amount if no domestic use election had been made.

    3. The accounting must be attached to, and filed by, the due date (including extensions) of the taxpayer’s income tax return for the taxable year in which the triggering event occurs.

4.61.13.5.3  (03-27-2009)
Rebuttal of Presumptive Rule of Full Interest Charge

  1. The taxpayer may rebut the full amount of the interest charge. See IRM 4.61.13.5.1.

  2. To rebut the full amount of the interest charge the taxpayer must demonstrate that the "net interest owed" is less than the presumptive full amount.

  3. The taxpayer demonstrates the lesser amount of net interest owed by computing the amount of interest owed had the taxpayer filed an amended return for the taxable year in which the DCL was incurred and any other affected taxable years up to and including the year of recapture and no domestic use election had been filed for the DCL.

    Note:

    The net interest owed is calculated by treating the additional tax owed on the presumptive full amount of recapture as due and owing from the year in which the DCL was incurred and then applying the SRLY rules, as modified by Treas. Reg. 1.1503(d).

  4. The taxpayer bears the burden of establishing the net interest amount owed.

    1. To satisfy its burden of establishing the net interest amount owed, the taxpayer must prepare a computation labeled "Reduction of Interest Charge"

    2. The computation must be attached to, and filed by, the due date (including extensions) of the taxpayer’s income tax return for the taxable year in which the triggering event occurs.

4.61.13.5.4  (03-27-2009)
Computation of Taxable Income in Year of DCL Recapture

  1. Presumptive rule. Except as provided in (2) below for the computation of the taxable income for the year of recapture, no current, carryover, or carryback losses may be used to offset and absorb the recapture amount. Treas. Reg. 1.1503(d)-6(h)(4)(i).

  2. Exception to presumptive rule.The recapture amount included in gross income may be offset and absorbed by that portion of a taxpayer’s NOL carryover that is attributable to the DRC or separate unit that incurred the DCL being recaptured.

    Note:

    The taxpayer must demonstrate to the satisfaction of the IRS the amount of NOL carryover that may absorb any part of the recapture amount. The taxpayer must prepare a computation demonstrating this and attach it to the timely filed income tax return for the taxable year in which the triggering event occurs.

  3. The recapture income will be treated as ordinary income. For additional rules on the character and source of recapture income, see Treas. Reg. 1.1503(d)-6(h)(5).

4.61.13.6  (03-27-2009)
Report Writing

  1. This section provides guidance for report writing for proposed adjustments related to DCLs.

4.61.13.6.1  (03-27-2009)
Report Writing for Disallowing the Use of a DCL

  1. If IRS personnel determine that the taxpayer used all or a part of a DCL to offset income of a domestic affiliate in the year the DCL was incurred, and no exception to the domestic use limitation applies, IRS personnel may propose to disallow that use of the DCL. IRS personnel should use a Form 5701, "Notice of Proposed Adjustment" , to propose the disallowance.

    Note:

    The disallowed DCL is subject to the domestic use limitation rule of Treas. Reg. 1.1503(d)-4 and basically treated as a SRLY loss for such DRC or separate unit.

  2. IRS personnel should prepare a Form 886-A , "Explanation of Items" , in addition to the Form 5701. The Form 886–A should:

    1. Identify the DRC or separate unit that incurred the DCL;

    2. List the tax year in which the DCL was incurred;

    3. Specify the amount of the DCL being disallowed; and

    4. Provide the reasons for the disallowance (egs. no domestic use election, mirror legislation) with proper citations to the DCL regulations.

      Note:

      The taxpayer may request reasonable cause relief for failure to timely make a domestic use election. See IRM 4.61.13.7.

4.61.13.6.2  (03-27-2009)
Report Writing for Recapturing a DCL

  1. If IRS personnel determine that a taxpayer must recapture a DCL because of the occurrence of one or more triggering events and no exception applies, IRS personnel may propose the recapture of the presumptive full amount of the DCL. IRS personnel should use a Form 5701 to propose the recapture.

    Note:

    The taxpayer may attach to a timely filed tax return for the taxable year in which an event described as a triggering event occurred, or provide in a request for reasonable cause relief, a statement rebutting that the event is a triggering event. See IRM 4.61.13.4.2.2.

    Note:

    The taxpayer may attach to a timely filed tax return for the taxable year in which a triggering event occurred, or provide in a request for reasonable cause relief, a separate accounting showing that the recapture amount is less than the full amount of the DCL. See IRM 4.61.13.5.2. If the taxpayer properly demonstrates a lesser recapture amount, the recapture amount will be the lesser amount so demonstrated.

  2. IRS personnel should prepare a Form 886–A in addition to the Form 5701. The Form 886–A should:

    1. Identify the DRC or separate unit which incurred the DCL;

    2. List the tax year of the DCL;

    3. Identify the domestic use election covering the DCL;

    4. Specify the amount of the DCL being recaptured;

    5. List the triggering events for the recapture;

    6. Compute the additional tax resulting from the recapture;

    7. Compute the interest charge; and

    8. Explain the proposed recapture and interest charge with proper citations to the DCL regulations.

    Note:

    See IRM 4.61.13.6.2.1. for additional guidance on the report writing for the interest charge upon recapture.

4.61.13.6.2.1  (03-27-2009)
Report Writing for the Interest Charge upon Recapture

  1. IRS personnel should include on the Form 5701 that proposes the recapture a separate line item for the amount of the interest charge that results from the recapture. The line item should be labeled "Interest Charge – Due to Dual Consolidated Loss Recapture" . See IRM 4.61.13.5.1. for computation of the interest charge.

  2. The following explanation of the interest charge should be included on the Form 5701:

    "An interest charge on the recapture is due under Treas. Reg. 1.1503(d)-6(h). The interest charge is computed under the rules of section 6601(a) by treating the additional tax resulting from the recapture as though it had been due and unpaid as of the date for payment of the tax for the taxable year in which the taxpayer received a tax benefit from the dual consolidated loss. The interest is computed to the due date of the tax return for the year of recapture (of if payment of the additional tax is made on an earlier date, to that earlier date) and the interest thus computed becomes a part of the tax liability for that taxable year. In this case, the interest is computed on $ (insert the amount of the additional tax resulting from the recapture of the DCL) for the period beginning (insert the due date of payment of the tax for the taxable year in which the taxpayer received a tax benefit from the DCL being recaptured) and ending (insert the due date of the tax return for the year of recapture) and will be part of the tax liability for the taxable year ending (insert ending date of the taxable year of recapture)."

4.61.13.6.3  (03-27-2009)
Report Writing for Interest Charge on Properly Reported DCL Recapture Amount

  1. If the taxpayer properly reports the correct amount of recapture of a DCL on its income tax return and pays the correct amount of additional tax on the recapture amount but fails to report and pay the interest charge, IRS personnel should propose an adjustment for the interest charge. IRS personnel should use a Form 5701 to propose this adjustment.

  2. IRS personnel should include on the Form 5701 a separate line item for the amount of the interest charge that results from the recapture. The line item should be labeled "Interest Charge – Due to Dual Consolidated Loss Recapture" . See IRM 4.61.13.5.1. for computation of the interest charge.

  3. The following explanation of the interest charge should be included on the Form 5701:

    "An interest charge on the recapture is due under Treas. Reg. 1.1503(d)-6(h). The interest charge is computed under the rules of section 6601(a) by treating the additional tax resulting from the recapture as though it had been due and unpaid as of the date for payment of the tax for the taxable year in which the taxpayer received a tax benefit from the dual consolidated loss. The interest is computed to the due date of the tax return for the year of recapture (of if payment of the additional tax is made on an earlier date, to that earlier date) and the interest thus computed becomes a part of the tax liability for that taxable year. In this case, the interest is computed on $ (insert the amount of the additional tax resulting from the recapture of the DCL) for the period beginning (insert the due date of payment of the tax for the taxable year in which the taxpayer received a tax benefit from the DCL being recaptured) and ending (insert the due date of the tax return for the year of recapture) and will be part of the tax liability for the taxable year ending (insert ending date of the taxable year of recapture)."

  4. IRS personnel should prepare a Form 886–A in addition to the Form 5701. The Form 886–A attached to the Form 5701 should:

    1. Reference the recapture of the DCL as reported on the return;

    2. Compute the interest charge; and

    3. Explain the interest charge with proper citations to the DCL regulations.

4.61.13.6.3.1  (03-27-2009)
Interest Charge on Computer Generated Examination Report

  1. If an interest charge adjustment is required, the examiner must include this amount as part of the tax liability for the taxable year of the triggering event.

  2. A manual calculation of the interest charge must be made. See IRM 4.61.13.5.1. for guidance on the interest charge calculation.

  3. For LMSB cases utilizing BNA to generate the examination report, the manually computed interest charge amount should be inputted under " Miscellaneous Taxes/Recapture " under " Other " on the main worksheet. The miscellaneous tax description for the interest charge should be inputted as " DCL Recapture Interest Charge " with the appropriate interest charge amount included in the amount field.

  4. For SB/SE cases utilizing RGS to generate the examination report, the interest charge amount should be inputted and identified under " Other Taxes " .

4.61.13.7  (03-27-2009)
Requests for Reasonable Cause Relief

  1. A taxpayer may fail to timely file a document relating to a DCL. For example, a taxpayer may fail to timely file a domestic use election or annual certification.

  2. The regulations provide a procedure by which a taxpayer may cure a failure to timely file documents related to DCLs. Treas. Reg. 1.1503(d)-1(c)(1). This procedure may be referred to as a " request for reasonable cause relief" .

  3. In a request for reasonable cause relief, the taxpayer must demonstrate that the failure to timely file a document relating to a DCL was due to reasonable cause and not willful neglect.

  4. The review, development and determination of the taxpayer's request for reasonable cause relief does not constitute or initiate an examination of any taxable year of the taxpayer.

  5. A taxpayer may not use IRC section 9100 relief procedures on requests for reasonable cause relief, with the exception of certain closing agreements and requests for letter rulings under Treas. Reg. 301.9100-1 through 301.9100-3 pending as of March 19, 2007.

4.61.13.7.1  (03-27-2009)
Filing the Request For Reasonable Cause Relief

  1. To make a request for reasonable cause relief, the taxpayer must file an amended return which amends the return to which the document(s) should have been attached. The amended return must include:

    1. the documents that should have been attached to the original return and,

    2. a written statement setting forth the reasons for the failure to timely comply.

  2. The taxpayer must file the original amended return referred to in this section with the applicable IRS Service Center with which the taxpayer filed its original return to which the documents should have been attached.

  3. In addition to filing the amended return referred to in this section with the Service Center, the taxpayer must provide a copy of the amended return and all required attachments to the Director (see paragraph (4) of this section for the definition of "Director" ) as follows:

    1. If the taxpayer is under examination for any taxable year when the taxpayer requests relief, the taxpayer must provide a copy of the amended return and attachments to the IRS personnel conducting the examination.

    2. If the taxpayer is not under examination for any taxable year when the taxpayer requests relief, the taxpayer must provide a copy of the amended return and attachments to the Director having jurisdiction of the taxpayer’s return.

    Note:

    For purposes of Treas. Reg. 1.1503(d)-1(c)(1) and this section, "any taxable year" means any taxable year and is not limited to a taxable year for which an amended return is filed to request reasonable cause relief.

    Note:

    IRS personnel should confirm with the taxpayer that the original amended return was filed with the Service Center.

  4. For purposes of Treas. Reg. 1.1503(d)-1(c)(1) and IRM 4.61.13.7, the "Director" is, as appropriate, the Area Director, Field Examination, Small Business/Self Employed (SB/SE) or the Director of Field Operations (DFO), Large and Mid-Size Business (LMSB) having jurisdiction over the taxpayer’s return for the taxable year.

    1. The authority of the Director to determine whether the taxpayer has established reasonable cause has been formally delegated to LMSB Team Managers and LMSB International Team Managers. Delegation Order LMSB-193-6. See http://lmsb.irs.gov/hq/c/LMSBDelOrders/lmsb193-6.asp for a copy of the Delegation Order.

    2. The authority of the Director to determine whether the taxpayer has established reasonable cause has been formally delegated to specific Examination management personnel in the Small Business/Self Employed Division pursuant to Delegation Order SB/SE 4.64. See http://sbse.web.irs.gov/MF/DelOrders/DelOrder.aspx?DO=Part4/DelOrder4-64.htm for a copy of the Delegation Order. See IRM 4.61.13.7.3.

      Note:

      Therefore, any reference under this IRM 4.61.13.7 to "Director" may also include any of these delegates.

  5. The taxpayer must file a separate amended return for each year it requests reasonable cause relief.

  6. It may not be appropriate to consider a request for reasonable cause relief if the period of limitations on assessment under section 6501(a) has expired for the tax year in which the DCL was incurred.

    Note:

    See Generic Legal Advice 2008-001 (January 22, 2008) in which IRS Office of Chief Counsel addresses, under several scenarios, whether it is appropriate for Examination to consider a request for reasonable cause relief where the period of limitations on assessment has expired for the tax year in which the underlying DCL was incurred.

4.61.13.7.1.1  (03-27-2009)
Timeliness of Request for Reasonable Cause Relief

  1. The Service will consider a request for reasonable cause relief only if the taxpayer files for the relief "once [the taxpayer] becomes aware of the failure" to timely file. Treas. Reg. 1.503(d)-1(c)(2)(i).

  2. If the taxpayer does not file the request for relief once it becomes aware of the failure to timely file, the Service should not consider the request.

    1. In this situation, it is recommended that the Service notify the taxpayer in writing that its request for relief can not be considered because the taxpayer failed to make the request in a timely manner.

4.61.13.7.2  (03-27-2009)
Processing the Receipt of a Request for Reasonable Cause

  1. Processing the receipt of a request for reasonable cause relief will depend on whether the taxpayer is under examination.

    • Taxpayer is under examination. If the taxpayer is under examination for any taxable year, the IRS personnel conducting the examination will receive a copy of the amended return and attachments. In this situation, it is recommended that the IRS personnel assigned to the examination should review and develop the issue of whether the taxpayer has demonstrated reasonable cause. In developing the issue, the IRS personnel should follow the procedures set forth in the regulations and this IRM section.

    • Taxpayer is not under examination. If the taxpayer is not under examination for any taxable year at the time of the taxpayer's request for reasonable cause, the Director having jurisdiction of the taxpayer’s return will receive a copy of the taxpayer's original amended return and attachments through which the reasonable cause relief is requested. See IRM 4.61.13.7.1. The Director may assign the review and development of whether the taxpayer has demonstrated reasonable cause to IRS personnel, as appropriate. See IRM 4.61.13.7.4. for guidance on developing the issue of reasonable cause.

      Note:

      The IRS Service Center with which the original amended return was filed does not provide the original or any copy of the amended return to IRS field personnel. The taxpayer provides a copy of the original amended return to the appropriate IRS personnel in the field.

  2. The review, development and determination of the taxpayer's request for reasonable cause relief does not constitute or initiate an examination of any taxable year of the taxpayer.

4.61.13.7.2.1  (03-27-2009)
Written Notification of Receipt and Assignment of Request for Reasonable Cause

  1. IRS personnel must notify the taxpayer in writing that the taxpayer’s request for reasonable cause relief has been received and assigned for review.

  2. IRS personnel should provide the written notification of receipt and assignment by issuing Letter 4291, Notification of Receipt and Assignment Letter for a Dual Consolidated Loss Reasonable Cause Request.

    Note:

    While the regulations do not provide a date by which the written notification of receipt and assignment must be provided to the taxpayer, IRS personnel should strive to assign the request and provide the written notification to the taxpayer as soon as reasonably possible.

  3. IRS personnel should provide a separate Letter 4291 for each taxable year for which the taxpayer filed an amended return.

4.61.13.7.2.2  (03-27-2009)
The 120 Day Determination Period

  1. On the date the taxpayer is notified in writing of the receipt and assignment ( See IRM 4.61.13.7.2.1.), a 120 day determination period prescribed by the regulations commences. Treas. Reg. 1.1503(d)-1(c)(1). The Director must notify the taxpayer in writing during this 120 day period if either of the following applies:

    1. it has been determined that the failure to comply was not due to reasonable cause or was due to willful neglect (or both).

    2. additional time is needed to determine whether the taxpayer has demonstrated reasonable cause.

  2. If the taxpayer is not provided written notification of the information set forth in this section (1)(a) or (b) during the 120 day period, the taxpayer will be deemed to have established reasonable cause.

    Note:

    The Director may, but is not required to, notify the taxpayer in writing during the 120 day period that it has been determined that the failure to comply was due to reasonable cause. For the administrative convenience of the Service and the taxpayer and as a best practice, it is recommended in all cases in which it is determined that the taxpayer has established reasonable cause that written notification be provided to the taxpayer. See IRM 4.61.13.7.4.1.

    Note:

    The 120 day period should be carefully monitored to ensure that reasonable cause is properly reviewed and developed and not inadvertently deemed established.

  3. If the taxpayer, prior to the expiration of the 120 day period, is notified in writing that additional time is needed, the 120 day period is no longer applicable. See IRM 4.61.13.7.5.

  4. See IRM 4.61.13.7.6. for requests by IRS personnel for additional information to develop the issue of reasonable cause.

4.61.13.7.3  (03-27-2009)
Authority to Determine Reasonable Cause

  1. The Director has the authority to determine whether the taxpayer has established reasonable cause.

  2. The authority of the Director to determine whether the taxpayer has established reasonable cause has been delegated to LMSB Team Managers and LMSB International Team Managers. Delegation Order LMSB-193-6. See http://lmsb.irs.gov/hq/c/LMSBDelOrders/lmsb193-6.asp for a copy of the Delegation Order.

  3. The authority of the Director to determine whether the taxpayer has established reasonable cause has been formally delegated to specific Examination management personnel in the Small Business/Self Employed Division pursuant to Delegation Order SB/SE 4.64. See http://sbse.web.irs.gov/MF/DelOrders/DelOrder.aspx?DO=Part4/DelOrder4-64.htm for a copy of the Delegation Order.

  4. Any reference made to the Director determining reasonable cause in this IRM includes any person delegated the authority.

  5. While the Director has the authority to determine reasonable cause, any appropriately assigned IRS personnel may develop the issue. See IRM 4.61.13.7.4. for guidance on developing the issue of reasonable cause.

4.61.13.7.4  (03-27-2009)
Guidance on Developing the Issue of Reasonable Cause

  1. This section provides guidance on developing whether the taxpayer has demonstrated reasonable cause.

4.61.13.7.4.1  (03-27-2009)
Determining Whether Reasonable Cause has been Demonstrated

  1. The IRS personnel charged with reviewing and developing the request for reasonable cause relief must develop whether the taxpayer has demonstrated that the failure to timely file was both

    1. due to reasonable cause and

    2. not due to willful neglect.

    Note:

    The taxpayer has the burden of demonstrating that the failure to timely file was both (1) due to reasonable cause and (2) not due to willful neglect.

  2. See IRM 4.61.13.7.4.2. for guidance to assist IRS personnel in developing whether the taxpayer has met its burden.

  3. IRS personnel should initially review the copy of the amended return to confirm that the amended return contains a statement setting forth the reasons for the failure to timely file.

    • If the amended return does not include a written statement setting forth the reasons for the failure to time file, the Director should notify the taxpayer in writing that its purported request is incomplete and does not conform to the requirements of Treas. Reg. 1.1503(d)-1(c)((2)(i) and its purported request will not be considered by the Service.

    Note:

    The review, development and determination of the taxpayer's request for reasonable cause relief does not constitute or initiate an examination of any taxable year of the taxpayer.

  4. If assistance is needed in making the factual determination whether the taxpayer has demonstrated that the failure to timely file was due to reasonable cause and not willful neglect, IRS personnel should first contact local field counsel.

4.61.13.7.4.2  (03-27-2009)
Reasonable Cause Criteria

  1. The Penalty Handbook at IRM 20.1.1.3.1 provides guidance on determining whether penalties imposed by the Code apply to a given case. IRM 20.1.1.1.2.

  2. The Penalty Handbook sets forth, in part, general guidelines and criteria for determining whether a taxpayer has established reasonable cause for relief from penalties. See IRM 20.1.1.3.1.

  3. The Penalty Handbook provides a convenient and adequate starting point for developing the issue of reasonable cause under Treas. Reg. 1.1503(d)-1(c)(1) since it includes criteria and suggested inquiries which are relevant generally in determining whether reasonable cause exists.

  4. The provisions of the Penalty Handbook which will likely be relevant to reasonable cause determinations under Treas. Reg. 1.1503(d)-1(c)(1) are discussed in this section. The discussion contained in this section is not intended to be an exhaustive discussion of reasonable cause as contained in the Penalty Handbook at IRM 20.1.1.3.1 or any other Penalty Handbook section.

  5. Numerous published court cases address the issue of reasonable cause under various Code sections, however none under section 1503(d) and Treas. Reg. 1.503(d)-1(c)(1).

4.61.13.7.4.2.1  (03-27-2009)
Reasonable Cause - General Guidelines

  1. The taxpayer bears the burden of demonstrating to the satisfaction of the Director that the failure to timely file was due to reasonable cause and not due to willful neglect.

  2. Reasonable cause is based on all the facts and circumstances in each situation and is generally granted when the taxpayer exercises ordinary business care and prudence in determining their tax obligations. See IRM 20.1.13.1.

  3. Reasonable cause should never be presumed. See IRM 20.1.1.3.1.2.1.

4.61.13.7.4.2.2  (03-27-2009)
Reasonable Cause - Common Inquiries

  1. Each request for reasonable cause relief must be judged individually based on the facts and circumstances at hand. IRM 20.1.1.3.1. The following is a list of general inquiries that IRS personnel should consider when developing whether the taxpayer has demonstrated reasonable cause for its failure to timely file:

    1. What happened and when did it happen?

    2. During what period of time was the taxpayer non-compliant and what facts and circumstances prevented the taxpayer from timely filing?

    3. How did the facts and circumstances prevent the taxpayer from complying with the filing requirements under the DCL regulations?

    4. What attempts did the taxpayer make to comply? See IRM 20.1.1.3.1.

4.61.13.7.4.2.3  (03-27-2009)
Ordinary Care & Prudence

  1. Treas. Reg. 1.1503(d)-1(c)(1) and the Penalty Handbook both provide that reasonable cause is based on all the facts and circumstances in each situation and is generally determined to exist when the taxpayer demonstrates that it exercised ordinary care and prudence in meeting its tax obligations but nonetheless did not comply with the prescribed duty within the prescribed time.

  2. In determining whether a taxpayer exercised ordinary care and prudence, IRS personnel should secure and review information which details the following:

    1. The taxpayer’s reason(s) for the non-compliance (including the reasons set forth in the written statement accompanying the taxpayer’s amended return)

    2. The taxpayer’s history of compliance (or non-compliance) with regards to filings related to DCLs. A first time occurrence of non-compliance does not by itself demonstrate reasonable cause.

    3. The length of time between the failure to comply with the filing requirements under the DCL regulations and the subsequent compliance, i.e. whether the taxpayer complied once it became aware of the failure to comply.

    4. Whether circumstances beyond the taxpayer’s control caused the taxpayer’s non-compliance. See IRM 20.1.1.3.1.2.

  3. The Penalty Handbook sets forth various reasons a taxpayer may assert to justify its non-compliance. See IRM 20.1.1.3.1.1. The following are more likely to be asserted by a taxpayer in a request for reasonable cause relief under Treas. Reg. 1.1503(d)-1(c)(1):

    1. Ignorance of the law. See IRM 20.1.1.3.1.2.1.

    2. Mistake, forgetfulness or oversight. See IRM 20.1.1.3.1.2.2. and IRM 20.1.1.3.1.2.3.

    3. Reliance on advice from a tax advisor. See IRM 20.1.1.3.2.4.

4.61.13.7.4.2.4  (03-27-2009)
Willful Neglect

  1. In addition to demonstrating reasonable cause, the taxpayer must demonstrate that its failure to comply was not due to willful neglect.

  2. The Penalty Handbook defines "willful neglect" as "conscious, intentional failure to comply with the provisions of the IRC, or reckless indifference to such provisions" . See IRM Exhibit 20.1.1-8.

  3. With the exception of subsection 2.3 immediately above, any reference in this IRM section (or reference to a form letter) to demonstrating or determining reasonable cause includes demonstrating or determining "willful neglect" .

4.61.13.7.5  (03-27-2009)
Determination that Additional Time is Needed

  1. During the 120 day period set forth in Treas. Reg. 1.1503(d)-1(c)(1) and in the course of reviewing the copy of the taxpayer’s amended return including the written statement setting forth the reasons for reasonable cause relief, the IRS personnel may conclude that additional time is needed to develop whether the taxpayer has demonstrated reasonable cause. In such a case, the Director should notify the taxpayer that additional time is needed. This will make the 120 day period inapplicable.

  2. The Director should use Letter 4294, Additional Time Notification Letter for Final Determination of the Dual Consolidated Loss Reasonable Cause, to notify the taxpayer that additional time is needed.

    Note:

    If additional information is also needed, the Director should use Letter 4296, Request for Additional Time and Information on Dual Consolidated Loss Reasonable Cause Determination, to request such additional information as well as provide written notification that additional time is needed.

  3. The issuance of Letter 4294 or Letter 4296 will make the 120 day determination period inapplicable. See IRM 4.61.13.7.2.2.

    Note:

    The issuance of Letter 4295, Request for Additional Information on Dual Consolidated Loss Reasonable Cause, does not suspend the 120 day determination period. See IRM 4.61.13.7.6.

  4. A manager with authority under Delegation Order LMSB 193-6 or Delegation Order SB/SE 4.64, as applicable, should sign and issue to the taxpayer the appropriate Letter 4294 or Letter 4296 to notify the taxpayer that additional time is needed. See IRM 4.61.13.7.3. for delegation of authority.

    Note:

    The issuance of Letter 4294 or Letter 4296 will make the 120 day period inapplicable.

  5. A separate additional time notification letter is issued as needed for each amended return.

4.61.13.7.6  (03-27-2009)
Request for Additional Information

  1. During the course of developing whether the taxpayer has demonstrated reasonable cause, IRS personnel may determine that additional information is needed from the taxpayer.

  2. IRS personnel should use Letter 4295, Request for Additional Information on Dual Consolidated Loss Reasonable Cause Determination, to request additional information.

  3. The additional information sought should be included in the body of the letter provided to the taxpayer. See Letter 4295.

    Note:

    A request for additional information via Letter 4295 during the 120 day period will not by itself render the 120 day period inapplicable. The Director must notify the taxpayer in writing that additional time is needed in order for the 120 days to be rendered inapplicable. See IRM 4.61.13.7.5.

  4. To avoid confusion, IRS Personnel should not use Information Documents Requests (IDRs) to request additional information because the review, development and determination of the taxpayer’s request for reasonable cause relief is not an examination of any taxable year of taxpayer.

4.61.13.7.7  (03-27-2009)
Determination that the Taxpayer Has Demonstrated Reasonable Cause - Acceptance of Reasonable Cause

  1. If the 120 day period is applicable and the Director determines that the taxpayer has demonstrated that its failure to comply was due to reasonable cause (and not willful neglect) it is recommended that the Director provide written notification of the determination to the taxpayer.

    1. Letter 4293, Acceptance of Taxpayer's Request for a Dual Consolidated Loss Reasonable Cause, should be used to notify the taxpayer that its request for reasonable cause relief has been accepted.

      Note:

      If no written notification at all is provided to the taxpayer during the 120 day period, the taxpayer will be deemed to have established reasonable cause. See IRM 4.61.13.7.2.2. The Director may notify the taxpayer in writing during the 120 day period that it has been determined that the failure to comply was due to reasonable cause. However, the Director is not required to provide this in writing since the taxpayer will be deemed to have established reasonable cause upon the expiration of the 120 days in the event no written notification is provided.

      Note:

      For the administrative convenience of the Service and the taxpayer and as a best practice, it is recommended in all cases in which it is determined that the taxpayer has established reasonable cause that written notification be provided to the taxpayer.

  2. If the 120 day period is not applicable (i.e. a Letter 4294 or Letter 4296 has been issued) and the Director determines that the taxpayer has demonstrated reasonable cause, the Director should provide written notification of the determination to the taxpayer.

    1. Letter 4293, Acceptance of Taxpayer's Request for a Dual Consolidated Loss Reasonable Cause, should be used to notify the taxpayer that its request for reasonable cause relief has been accepted.

  3. In any event, the Director is the only IRS personnel who provides the written notification of determination to the taxpayer.

    Note:

    The authority of the Director to determine reasonable cause has been delegated to certain managers but not to revenue agents or international examiners. See IRM 4.61.13.7.3. As a result, revenue agents and international examiners may not sign Letter 4293.

  4. A separate written notification of the Service’s determination should be provided for each taxable year for which the taxpayer filed an amended return requesting reasonable cause relief.

    Note:

    Letter 4293 is the only documentation that the taxpayer will receive from the Service that its request for reasonable cause relief was accepted.

  5. If the taxpayer is currently under examination for any taxable year, IRS personnel should charge time spent working the request for reasonable cause relief to the current examination cycle of the taxpayer or the examination of the taxable year for which the amended return was filed.

  6. If the taxpayer is under the Coordinated Industry Case (CIC) program, a copy of the acceptance letter should be incorporated into the planning file for future reference.

  7. If the taxpayer is not currently under examination, the examiner should charge the time spent working the request for reasonable cause relief to the Miscellaneous Examination Activity Code 514 - Specialist Consultations or Informal Assistance. The review, development and determination of the taxpayer's request for reasonable cause relief is not an examination of any taxable year of the taxpayer.

  8. The IRS Service Center with which the original amended return was filed does not provide the original or any copy of the amended return to IRS field personnel. The taxpayer provides a copy of the original amended return to the appropriate IRS personnel in the field. See IRM 4.61.13.7.9. for the recommended administrative procedures for the retention of the determination letter sent to the taxpayer and/or any related documents/workpapers.

4.61.13.7.7.1  (03-27-2009)
Consequences of Reasonable Cause

  1. If the Director determines that the taxpayer has demonstrated reasonable cause, or the taxpayer is deemed to have established reasonable cause, the only consequence is that the DCL filing at issue will be considered to have been timely filed.

  2. A determination by the Director that the taxpayer has demonstrated reasonable cause, or a situation in which reasonable cause has been deemed to have been established, is not a finding that the taxpayer was eligible to file the DCL filing (e.g. domestic use election) at issue. It is also not a finding that any amount, date, representation, etc. contained on the DCL filing at issue is correct. These issues may be addressed, as appropriate, during an examination.

    Note:

    Reasonable cause relief is not a finding on any substantive issue involving the DCL. The information contained in the DCL filing at issue should only be considered in an examination of the DCL after, and only if, the taxpayer's request for reasonable cause relief has been demonstrated or deemed established.

4.61.13.7.8  (03-27-2009)
Determination that the Taxpayer Has Not Demonstrated Reasonable Cause - Denial Of Reasonable Cause

  1. If the Director determines that the taxpayer has not demonstrated reasonable cause, the Director provides written notification of this determination to the taxpayer.

    1. The Director should use Letter 4292, Denial of Taxpayer's Request for a Dual Consolidated Loss Reasonable Cause, to notify the taxpayer that its request for reasonable cause relief has been denied.

  2. The Director is the only IRS Personnel who may provide written notification of the determination to the taxpayer.

    Note:

    The authority of the Director to determine reasonable cause has been delegated to certain managers but not to revenue agents or international examiners. See IRM 4.61.13.7.3.. As a result, revenue agents and international examiners may not sign Letter 4292.

  3. A separate written notification of the Service’s determination should be provided for each taxable year for which the taxpayer filed an amended return requesting reasonable cause relief.

    Note:

    Letter 4292 is the only documentation that the taxpayer will receive from the Service that its request for reasonable cause relief was denied.

  4. If the taxpayer is currently under examination for any taxable year, IRS personnel should charge time working the request for reasonable cause relief to the current examination cycle of the taxpayer or the examination of the taxable year for which the amended return was filed.

  5. If the taxpayer is under the Coordinated Industry Case (CIC) procedure, a copy of the denial letter should be retained in the planning file for future reference.

  6. If the taxpayer is not currently under examination, the examination should charge the time spent working the request for reasonable cause relief to the Miscellaneous Examination Activity Code 514 - Specialist Consultations or Informal Assistance. The review, development and determination of the taxpayer's request for reasonable cause relief is not an examination of any taxable year of the taxpayer.

  7. The IRS Service Center with which the original amended return was filed does not provide the original or any copy of the amended return to IRS field personnel. The taxpayer provides a copy of the original amended return to the appropriate IRS personnel in the field. See IRM 4.61.13.7.9. for the recommended administrative procedures for the retention of the determination letter sent to the taxpayer and/or any related documents/workpapers.

4.61.13.7.8.1  (03-27-2009)
Consequences of No Reasonable Cause

  1. If the Service determines that the taxpayer has not demonstrated reasonable cause, the DCL filing at issue will be considered to have not been timely filed.

    Note:

    As a result, the DCL filing should not be considered in the examination of the DCL issue.

  2. The denial of reasonable cause is not a determination of any substantive tax issue.

  3. The denial of reasonable cause by itself does not result in an adjustment to the taxpayer’s income or any other adjustment.

  4. The Service should independently consider the substantive tax consequences of the failure to file in order to determine whether to propose any adjustments on an examination.

    1. For example, if the Service denies a taxpayer’s request for reasonable cause relief to file a domestic use election the taxpayer would have no valid domestic use election for the DCL. Generally, the taxpayer would be prohibited from using the DCL to offset income of a domestic affiliate in the taxable year the DCL was incurred. For the Service to propose the disallowance of the full amount of the DCL as an adjustment to the taxpayer’s income, the taxpayer would need to be under examination for that taxable year. As a result of the adjustment, the disallowed DCL amount is subject to the domestic use limitation rule and is treated as a SRLY loss of the DRC or separate unit that incurred the loss. See IRM 4.61.13.6.1. for report writing on the disallowance of the DCL in the year the DCL was incurred.

    2. For example, if the Service denies a taxpayer’s request for reasonable cause relief to file an annual certification, the lack of a timely filed annual certification would be a triggering event. Generally, the taxpayer would be required to recapture the full amount of the DCL in gross income in the year of the triggering event. For the Service to propose to include the full amount of the DCL recapture as an adjustment to the taxpayer’s income, the taxpayer would need to be under examination for the year of the triggering event. See IRM 4.61.13.6.2. for report writing on the recapture of a DCL.

  5. If the taxpayer is not under examination, the Service should consider whether to initiate an examination of the taxpayer in order to propose any adjustments resulting from the failure to timely file. In addition to factors generally considered in deciding whether to initiate an examination, the Service should consider:

    1. Periods of limitations on assessment and,

    2. Assessment of risk on the proposed adjustment.

  6. If the decision is made to initiate an examination, Master File controls should be secured under normal case procedures and the DCL issue should be raised. See IRM 4.61.13.6. for report writing guidance on DCL audit adjustments.

  7. If the Service proposes an adjustment to income which relates to a DCL document for which reasonable cause relief has been denied, IRS personnel should in its audit report explain the request for reasonable cause relief and the Director’s decision to deny the relief.

  8. The taxpayer cannot protest to Appeals a denial of a request for reasonable cause relief by itself. The taxpayer may submit a protest of a proposed adjustment to income made as a result of an examination that relates to a DCL document for which reasonable cause relief was denied. In this protest, the taxpayer may raise issues regarding the denial of its request for reasonable cause relief.

  9. The determination of a request for reasonable cause relief, including the review and development of reasonable cause, is not by itself an examination and therefore no Master File controls are established. See IRM 4.61.13.7.9. for the recommended procedures for the retention of the determination letter sent to the taxpayer and/or any related documents/workpapers.

4.61.13.7.9  (03-27-2009)
Administrative Procedures on Reasonable Cause Determination Workpapers

  1. The determination of a request for reasonable cause relief, including the review and development of reasonable cause, is not by itself an examination.

  2. Once the determination of the request for reasonable cause relief is made (or deemed), this section should be followed to administratively process the determination letter sent to the taxpayer ("determination letter" ) and/or related documents and workpapers.

  3. As discussed below, the administrative procedure differs depending on whether the taxable year for which the request was made is under examination.

4.61.13.7.9.1  (03-27-2009)
Administrative Procedures for Reasonable Cause Determination for Tax Year Not Currently Under Examination

  1. ) This section provides the administrative procedures that should be followed where the taxable year for which the request for reasonable cause relief was made is not under examination and will not be examined.

  2. The following steps should be taken to associate a copy of the determination letter and any other related documents with the amended return filed by the taxpayer with the Service Center:

    1. Secure a Master File transcript for the tax year for which the request for reasonable cause relief was filed.

    2. Locate the Transaction Code (TC) 290 that represents the posting of the amended return filed by the taxpayer with the Service Center. The Document Locator Number (DLN) for the TC 290 represents the "controlling DLN" of the amended return with which the determination letter and/or any related document and workpapers should be associated.

      Note:

      If the tax year was previously examined, the DLN associated with TC 300 or TC 301 should be used as the " controlling DLN" for purposes of associating the determination letter and/or any related document and workpapers.

    3. Prepare a Form 9856, Attachment Alert, and attach thereto a copy of the determination letter and/or any related documents and workpapers.

      Note:

      The following fields/sections of the Form 9856 should be completed: Controlling DLN, Employee IDRS Number, Date Prepared, Stop Number and Alpha, EIN/SSN, Name Control, Form, and Period Ending.

      Note:

      The controlling DLN associated with the TC 290 posting on the Master File Transcript (or the TC 300 or 301 DLN, if appropriate) should be used on the Form 9856.

    4. Submit the Form 9856 through proper administrative channels to the appropriate Service Center Campus for refiling.

  3. A separate Form 9856 should be prepared for each taxable year for which the taxpayer has made a request for reasonable cause relief. The steps outlined above under (2) should be followed for each Form 9856.

    Note:

    If the taxpayer is deemed to have established reasonable cause pursuant to Treas. Reg. 1.1503(d)-1(c)(1), IRS personnel should prepare a memorandum that states this and include the memo in workpapers.

4.61.13.7.9.2  (03-27-2009)
Administrative Procedures for Reasonable Cause Determination for Tax Year Currently Under Examination or Will Be Under Examination Due to the Reasonable Cause Determination

  1. This section provides the administrative procedures which should be followed where the taxable year for which the request for reasonable cause relief was made is:

    1. Under examination at the time of the filing or

    2. Becomes under examination after the filing.

    Note:

    This includes where the taxable year becomes under examination solely because of a denial of the request for reasonable cause relief.

  2. A copy of the determination letter and/or any related documents and workpapers should be incorporated into the audit workpapers for the taxable year for which the request for reasonable cause relief was made.


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