Chapter 8: Consolidated Tax Returns

CONSOLIDATIONS (1 of 2) Affiliated groups Advantages & disadvantages of consolidating Consolidated taxable income Consolidated regular tax liability Consolidated AMT liability

CONSOLIDATIONS (2 of 2) Intercompany transactions Consolidated dividends Consolidated charitable contributions Consolidated NOLs Other consolidated items Stock basis adjustments

Affiliated Groups (1 of 3) Parent must directly own 80% of voting power & 80% of total value of stock of at least one subsidiary Parent & other group members must own 80% of the voting power & 80% of value of each corporation to be included in the group

Affiliated Groups (2 of 3) Excluded corporations Tax exempts under §501 Insurance companies Foreign corporations Corporations claiming §936 possessions tax credit Regulated investment companies Real estate investment trusts

Affiliated Groups (3 of 3) Excluded corporations (continued) Domestic international sales corporations (DISC) S corporations Partnerships and LLCs who choose to be taxed as corps (under check-the-box regs) may be part of an affiliated group

Advantages of Consolidating Losses in one member offset gains in another in the current year Intragroup dividends are eliminated Combined credit and deduction may avoid carryovers Intragroup gains are deferred Consolidated AMT may reduce the negative effects of AMT adjustments

Disadvantages of Consolidating Election binding on subsequent years Members must use same tax year Intragroup losses are deferred Intragroup losses may prevent a profitable member from taking credits Additional administrative cost

Consolidated Taxable Income (1 of 2) Compute each member’s income Adjust each member’s income Adjustments made to take into account special consolidated treatment Eliminate any item that is reported on a consolidated basis Resulting amount is separate taxable income

Consolidated Taxable Income (2 of 2) Combine separate taxable income (STI) of each member Resulting amount is combined TI Adjust combined taxable income for items reported on a consolidated basis Resulting amount is consolidated taxable income (or NOL) See Table C8-1

Consolidated Regular Tax Liability (1 of 2) Multiply consolidated taxable income by the appropriate tax rate(s) in §11 If affiliated group chooses files separate tax returns, reduced tax rates on lower income apply only one time regardless of number of members in group

Consolidated Regular Tax Liability (2 of 2) Affiliated groups may claim all tax credits available to corporations Determined on a consolidated basis

Consolidated AMT Liability AMT prepared on a consolidated basis for all group members Computation parallels determination of group’s consolidated taxable income

Intercompany Transactions (1 of 2) Transactions between corporations that are members of the same affiliated group immediately after the transaction

Intercompany Transactions (2 of 2) Examples include: Transfers of property Performance of services Licensing of technology Renting of property Lending of money Payment of a dividend to a parent

Transfers of Property (1 of 2) Group members recognize gain or loss on intercompany property transfers in computing separate taxable income Intercompany gain or loss excluded from consolidated income until a later event triggers recognition.

Transfers of Property (2 of 2) Recognition triggers: Buyer claims depreciation, amortization or depletion on purchased asset Amortization of capitalized services Departure from the group by either buyer or seller Parent starts a separate return year

Other Intercompany Transactions Both parties report their side of the transaction in determining separate taxable income Net effect upon consolidation is zero If parties use different methods or tax years, adjustments to match income and expense are required

Consolidated Dividends Dividends received from other group members are excluded from consolidated income Dividends-received deduction applied on a consolidated basis for dividends from non-group member corporations

Consolidated Charitable Contributions The affiliated group’s charitable contribution deduction is computed on a consolidated basis Sum the individual contributions 10% limitation based on adjusted consolidated taxable income Same as adjusted taxable income for a corporation Carryover the excess for 5 years

Consolidated NOLs (1 of 2) Consolidating income matches income from one member with losses from another, reducing taxable income Carrybacks and carryforwards done on consolidated basis if group has not changed its members Carryback 2 yrs and forward 20 years

Consolidated NOLs (2 of 2) Special loss limitations may apply Separate return limitation year (SRLY) §382 limitation (Loss group)

Separate Return Limitation Year (SRLY) (1 of 2) Parent-sub relationship exists Subsidiary has been filing separate returns and has NOLs Upon joining group, the sub’s losses can be used to offset future consolidated income subject to limitations

Separate Return Limitation Year (SRLY) (2 of 2) SRLY rules also apply to carrybacks for corporations who leave group and later carryback NOLs to consolidated years

§382 Limitation (1 of 2) §382 limitation applied when unrelated corp (or group) added as a subsidiary and has NOLs Limitation determines dollar amount of loss carryforward from new sub (or sub group) that can be applied to reduce consolidated taxable income

§382 Limitation (2 of 2) Loss limitation determined by multiplying the value of the loss group times the appropriate federal interest rate Loss group value is value of all common & pref stock owned by outsiders immediately before change of ownership

Consolidated Capital Gains & Losses §1231 gains and losses and capital gains and losses computed on a consolidated basis Eliminated from STI SRLY and §382 rules apply to capital loss carrybacks and carryforwards

Other Consolidated Items Adjusted combined taxable income includes All capital gains and losses on current transactions with outsider Net capital loss carryover or carrybacks §1231 gains or losses Casualty and theft gains or losses

Stock Basis Adjustments (1 of 2) Annually, basis for investment in a subsidiary corporation is adjusted Adjustment parallels the “equity” method of accounting for investments but uses tax numbers instead of book income numbers

Stock Basis Adjustments (2 of 2) Large negative basis adjustments can reduce a sub’s stock basis to $0 Negative basis adjustments when sub’s basis is $0 creates an excess loss account Subsequent positive adjustments reduce (or eliminate) the excess loss account

End of Chapter 8 Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com