Category: Deductions & Credits; Corporations
Subject: Jobs Tax Credits Carryover
Title: Unused Job Tax Credits, Survival of Section 196 Carryover
on Termination of S Election
IRC Sections: 196, 1371(b)
Filename: 1211.html
Date Produced: 03/95 Copyright 1998, The Tax Resource Group. All rights reserved.
Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background
S corporation taxpayer (TP) is engaged in the restaurant business.
TP generated substantial unused jobs tax credits during prior
C corporation years, and the fifteen year carryforward period
for those credits expires soon (or has already expired). Under
Internal Revenue Code Section 196, expiring unused general business
credits (including the jobs tax credit) become a deduction in
the first tax year after the fifteen year carryforward expires. Internal Revenue Code Section 1371(b) prohibits corporate level
carryovers to an S corporation of items arising in C corporation
years. TP plans to revoke its S election at some point in the future
but after the expiration of the carryforward period for its unused
jobs tax credits. Issue
Will a deduction equal to the expired jobs tax credits be available
to TP on conversion to C corporation status? Answer
I can find nothing in the tax literature to address this issue. Discussion
Section 196 was enacted in 1982 by PL 97-248 (TEFRA). The committee
reports surrounding enactment of Section 196 are absolutely unremarkable.
As a practical matter, the net effect of Section 196 is to convert
an expiring general business credit carryforward into either a
current deduction or a new net operating loss (with a brand new
15 year carryforward period). Section 1371 was enacted in 1982 by PL 97-354. The committee
reports surrounding enactment of Section 1371 are equally unremarkable. It is reasonably clear that the two provisions traveled through
Congress at roughly the same time, but neither the statutory language
nor the legislative history of either provision reveals any hint
that Congress considered how the two provisions might interact. From the plain reading of Section 1371(b), it is clear that
Congress intended to erect a "barrier" between C corporation
and S corporation years through which no carryover item could
pass. Clearly, the jobs credit carryover, even as transmuted into
a deduction by Section 196, would seem to come under the all-encompassing
language of Section 1371(b). Hence it is fairly clear that TP
cannot enjoy a deduction for unused jobs credit in the year following
expiration of the credit carryforward period. The issue is really whether that deduction which would have
been allowable but for Section 1371(b) somehow lies dormant until
TP again becomes a C corporation. Again, the tax literature seems
to provide no support one way or the other. I would like to present the following logical case for carrying
the deduction forward. -An S election does not destroy the ability to carry forward
unused credits or net operating losses generated in C corporation
tax years. These items are merely prevented by Section 1371(b)
from being taken into account at the corporate level during S
corporation tax years (except to reduce corporate level tax imposed
under the built-in gain rules). -Intervening S corporation years count as carryforward years
in determining the expiration of the carryforward items. Section
1371(b)(3). -The practical effect of Section 196 is to transmute an expired
credit into a deduction eligible to produce a net operating loss
subject to a brand new fifteen year carryforward. -A C corporation credit expiring in an S corporation year
should logically be transmuted into a C corporation net operating
loss carryforward with a new fifteen year carryforward. This
net operating loss would then lie dormant until the taxpayer
again becomes a C corporation or until the new fifteen year carryforward
period expires. This result seems entirely consistent with both
the statutory language and the clear legislative intent of both
these provisions. -This conclusion is far from doubt-free and far from risk-free.
Clearly, neither Congress nor IRS has anticipated this issue.
The IRS could well argue that there is absolutely no statutory
authority for this conclusion and thus disallow any net operating
loss carryforward to TP's first C corporation year attributable
to this item. -It seems to me that TP should strongly consider a private
ruling on this issue.
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