IRS Email Advice Concludes Tax Refund Is Gross Income

Grant Thornton writes: The IRS has released chief counsel advice (ECC 2013-10-039) addressing the tax consequences of a federal income tax refund. The situation addressed by the advice involved a buyer who had purchased stock in two subsidiaries from a seller. The buyer agreed in the purchase agreement to waive the carryback of net operating losses (NOLs) that the two subsidiaries would incur.

After the purchase, and after the two subsidiaries incurred NOLs, the buyer and seller entered into a new agreement NOT to waive the NOL carryback. The seller contracted to keep a certain percentage of the refund (such refund was generated when the two subsidiaries’ NOLs were carried back to the seller’s consolidated tax year) and pay the balance of the refund to the buyer. This change of heart may have occurred when the buyer realized that the NOLs were not usable currently or in the near future and that the opportunity for a percentage of immediate usage was a better option.

The email advice concludes that since the subsidiaries were the “owners” of the refund, not the seller, the seller should not be treated as receiving a nontaxable federal income tax refund. Instead, the IRS viewed the percentage retained by the seller as consideration for entering into the new contract to split the refund with buyer.