Can a Department of Revenue auditor reduce a taxpayer’s deduction for a net operating loss (“NOL”) carryforward, even if the NOL was generated in a tax year that is closed under the statute of limitations? This question is the subject of an appeal currently pending at the ATB. The appeal involves a telecommunications company that was audited for the 2007 – 2009 tax years. The taxpayer had an NOL carryforward that it applied to reduce Massachusetts taxable income for years during the audit period. As part of the audit, the Department disallowed the taxpayer’s deductions for interest paid to affiliates under a cash management system, increasing the taxpayer’s income subject to tax. But the Department then went a step further. According to the taxpayer’s petition, the Department also reviewed the taxpayer’s interest deductions for the years in which the taxpayer generated the NOL carryforward deducted in the years included in the audit period. The Department disallowed the interest deductions claimed for payments to affiliates under the cash management system for these otherwise closed years, resulting in a reduction to the taxpayer’s claimed deduction for NOL carryforwards during the years included in the audit. In effect, the Department conducted an audit of a year that would otherwise have been closed by statute, in order to make adjustments that could be carried forward to open tax years. The taxpayer is arguing that the adjustments to its NOL carryforwards are invalid, in part, because the Department does not have the authority to revise its net income (or loss) for years that are otherwise closed by the statute of limitations. Opportunity for Taxpayers: This case should serve as a reminder to taxpayers under audit or filing a refund claim to consider whether they have additional issues that could create or increase an NOL in a prior year, which could then be carried forward and used in the year that is the subject of the audit or refund claim, even if the prior year would otherwise be outside the statute of limitations. For example, suppose a taxpayer faces an audit adjustment for the 2012 tax year. However, for the 2008 tax year (a year for which the limitations period for filing a refund claim has closed), the taxpayer erroneously added back interest paid to an affiliate for which an exception to add back was available. If the exception had been claimed, the interest deduction would have resulted in an NOL that would have been available for carryforward to the 2012 tax year. When appealing the 2012 tax year assessment, the taxpayer should consider both challenging the audit adjustment for the 2012 tax year and arguing for an increase in its NOL carryforward from the 2008 tax year as an offset issue. Closing agreements can address NOL carryovers: This case should also serve as a reminder to taxpayers settling an audit or appeal through a closing agreement to carefully review how NOL carryforwards are addressed in the agreement.Taxpayers should consider their NOL situation carefully before entering into a closing agreement, and consider whether it is beneficial to request an agreement that specifies the amount of NOL carryforwards or that is silent on the issue. In many cases, a closing agreement can address NOLs that are carried forward to years beyond those covered by the agreement (especially for unitary combined filing tax years, where the various members of a unitary group may have “siloed” NOLs). Our experience is that the Department, in some cases, is open to including a provision in a closing agreement that specifies the amount of NOLs available for carryforward out of the years covered by the closing agreement on an entity-by-entity basis. This type of agreement provides certainty to both the Department and the taxpayer regarding the total amount of net operating losses that can be carried forward.