1. Consolidated Tax Returns
Chapter 8
Consolidated Tax Returns

2. Reasons for Using Multiple Entities (slide 1 of 3)
Isolate assets of certain ventures from liabilities of other ventures (i.e., obtain limited liability)
Carry out estate planning objectives

3. Reasons for Using Multiple Entities (slide 2 of 3)
Define upper limit on losses in joint venture with outside party by establishing minimally funded subsidiary to participate in venture
Shield identities of true owners of venture

4. Reasons for Using Multiple Entities (slide 3 of 3)
Enhance market value of entity assets by taking advantage of goodwill or trade names of certain members

5. Consolidated Return Advantages (slide 1 of 3)
Current losses can offset income of other members and reduce current regular tax or AMT
Operating and capital loss carryovers of one member may be used to offset income of other members

6. Consolidated Return Advantages (slide 2 of 3)
Taxation of intercompany dividends may be eliminated
Income on certain intercompany transactions can be deferred

7. Consolidated Return Advantages (slide 3 of 3)
Certain deductions and tax credits can be better utilized when subject to limitations of overall group rather than individual members
Basis in stock owned in lower tier entities is increased as income is reported

8. Consolidated Return Disadvantages (slide 1 of 3)
Election is binding on all members for current and all subsequent years’ returns
Election may be terminated if:
IRS consents to revocation, or
If membership in group changes and new member is not included in election

9. Consolidated Return Disadvantages (slide 2 of 3)
Losses on intercompany transactions are deferred
Certain deductions and tax credits may be reduced if limitations are determined based on activities of entire group

10. Consolidated Return Disadvantages (slide 3 of 3)
Basis in stock owned in lower tier entities is reduced if losses from the subsidiary are reported
Additional reporting requirements exist, and additional administrative procedures are necessary

11. The Consolidated Return Election

12. Electing Consolidated Return Status
A corporation can elect to join in a consolidated return if:
It is a member of an affiliated group
It is not ineligible to file on a consolidated basis
It meets initial and ongoing requirements

13. Affiliated Group (slide 1 of 3)
Exists when one corporation owns at least 80% of voting power and stock value of another corporation
Ownership test must be met every day of tax year
Multiple tiers and chains of corporations are allowed
Must have an identifiable parent corporation
At least 80% of one corporation must be owned by another

14. Affiliated Group (slide 2 of 3)
Affiliated group members can file tax returns in two ways:
Each member files a separate return
Claim a 100% dividends received deduction for payments passing among them
Elect to file consolidated tax returns
No 100% dividends received deduction is allowed for payments among group members
Election may not be binding for state purposes

15. Affiliated Group (slide 3 of 3)

16. Affiliated Versus Controlled Group
An affiliated group is similar but not identical to a parent-subsidiary controlled group
Members of a controlled group are
Required to share a number of tax benefits, including:
Discounted marginal tax rates on the first $75,000 of taxable income
The $150,000 or $250,000 accumulated earnings credit
The $40,000 exemption in computing AMT liability
Must defer recognition of realized loss on intercompany sales until sale is made at a gain to a nongroup member
Must recognize as ordinary income gain on the sale of depreciable property between controlled group members

17. Parent-subsidiary Controlled Group
Exists when one corporation owns at least 80% of voting power or stock value of another corporation on the last day of the year
Can have multiple tiers of subsidiaries and chains of ownership
Must have an identifiable parent

18. Entities Not Eligible for Consolidation Election
Entity type:
Corporations established outside the US or in a US possession
Tax-exempt (charitable) corporations
Insurance companies
Partnerships, trusts, estates, limited liability entities, or other noncorporate entities
These corporations cannot be used to meet the stock ownership tests and their incomes cannot be included in the consolidated return

19. Are these Eligible Groups?

20. Compliance Requirements (slide 1 of 5)
Initial consolidated return must meet the following requirements:
Form 1120 should include income of all members of consolidated group
Form 1122 is filed with first consolidated tax return
Represents consent by all entities to be included in consolidated group
Election must be made no later than the extended due date of parent’s return

21. Compliance Requirements (slide 2 of 5)
Subsequent consolidated returns:
Form 851 is included, which identifies all group members and shareholdings among the members
Form 851 also lists estimated tax payments made by any member during year

22. Compliance Requirements (slide 3 of 5)
Liability for taxes:
Each member is jointly and severally liable for entire consolidated tax liability, penalties and interest
Starting with third consolidated tax year, estimated tax payments must be made on consolidated basis

23. Compliance Requirements (slide 4 of 5)
Tax liability calculation
Regular tax is determined using graduated tax rates on consolidated income
Lower tax brackets are allocated equally to all members unless an election is made to allocate such benefits differently
Alternative minimum tax liability is based on consolidated AMTI of group
Group gets only one $40,000 exemption
ACE adjustment is computed using consolidated amounts

24. Compliance Requirements (slide 5 of 5)
Accounting periods and methods:
Tax year of parent must be used by all members
Short-year return may be required for the first year a subsidiary is included in the consolidated return
Accounting methods in place at the date of the election continue to be used

25. Stock Basis of Subsidiary (slide 1 of 7)
Parent corporation’s basis in the subsidiary’s stock is:
Initially, the acquisition price
Adjusted at end of each tax year
Prevents double taxation of gain or loss on ultimate disposal of subsidiary’s shares

26. Stock Basis of Subsidiary (slide 2 of 7)
Positive adjustments: Basis in subsidiary is increased by:
Allocable share of consolidated taxable income for year
Allocable share of consolidated operating or capital loss of subsidiary that could not use the loss through carryback to a prior year
Contributions to capital of subsidiary

27. Stock Basis of Subsidiary (slide 3 of 7)
Negative adjustments: Basis in subsidiary is reduced by:
Allocable share of consolidated taxable loss for year
Allocable share of operating or capital loss carryover deducted on consolidated return which did not previously reduce basis in subsidiary’s stock
Dividends paid by subsidiary to the parent out of E & P

28. Stock Basis of Subsidiary (slide 4 of 7)
When postacquisition taxable losses of subsidiary exceed acquisition price, an excess loss account is established
Allows consolidated return to recognize losses of subsidiary in current year
Enables group to avoid reflecting a negative stock basis in subsidiary

29. Stock Basis of Subsidiary (slide 5 of 7)
If stock of subsidiary is redeemed or sold to third party, any balance in excess loss account is recognized as capital gain

30. Stock Basis of Subsidiary (slide 6 of 7)
In a chain of more than one tier of subsidiaries, begin computation of stock basis in lowest-level subsidiary
Proceed up the ownership structure to parent

31. Stock Basis of Subsidiary (slide 7 of 7)
There is no such concept as consolidated E & P
Each entity accounts for its share of consolidated taxable income
Immediately recognizes within E & P any deferred gain or loss on intercompany transactions
Reduces E & P by allocable share of consolidated tax liability

32. Computing Consolidated Taxable Income (slide 1 of 3)
Sequential Approach:
Compute taxable income separately for each member of group
“Group items” and “intercompany items” are isolated and receive special treatment
Remaining separate incomes are combined with group and intercompany items, resulting in consolidated taxable income

33. Computing Consolidated Taxable Income (slide 2 of 3)
This computational procedure allows several transactions to be accounted for on a consolidated basis
e.g., charitable contributions, capital gains and losses

34. Computing Consolidated Taxable Income (slide 3 of 3)

35. Intercompany Transactions (slide 1 of 4)
Most intercompany transactions remain in the members’ separate taxable income
Effectively cancel each other out on a consolidated basis

36. Intercompany Transactions (slide 2 of 4)
Most intercompany transactions remain in the members’ separate taxable income (cont’d)
e.g., Services provided by one member to another member
Services provider recognizes income
Service purchaser recognizes deductible expense
Net result is a zero addition to consolidated taxable income

37. Intercompany Transactions (slide 3 of 4)
When members involved in the intercompany transaction use different accounting methods
Payor’s deduction for intercompany expenditure is deferred until year in which recipient recognizes the related gross income

38. Intercompany Transactions (slide 4 of 4)
Dividends received from other group members
Eliminated from recipient’s separate taxable income
No dividends received deduction allowed
If dividend is noncash asset
Payor member realizes gain but defers recognition until asset leaves the group
The (eliminated) dividend amount = FMV of asset received

39. Member’s NOLs (slide 1 of 6)
Usual corporate provisions for NOLs are available for consolidated losses
Carryback 2 years
Then forward 20 years
Election to forgo carryback for all members is available

40. Member’s NOLs (slide 2 of 6)
In computing consolidated NOL
Remove consolidated charitable contributions and capital gain or loss from taxable income
These items have their own carryover periods and rules
The consolidated dividends received deduction remains a part of the consolidated NOL

41. Member’s NOLs (slide 3 of 6)
Complications arise when group members enter or depart from the consolidated group
Members’ NOLs are either incurred in a “separate return year” and deducted in a “consolidated return year” or vice versa
Several restrictions limit the availability of such NOL deductions

42. Member’s NOLs (slide 4 of 6)
Where members of consolidated group change over time, consolidated NOL must be apportioned to group members using the following formula:
Member’s separate NOL × Consolidated NOL
Members’ aggregate NOL
= Member’s apportioned NOL

43. Member’s NOLs (slide 5 of 6)
In years when group member files a separate return, only the apportioned NOL may be carried over
When member leaves the group, any apportioned share of unused loss carryforwards can be used on its subsequent separate returns

44. Member’s NOLs (slide 6 of 6)
Separate return limitation year (SRLY) rules apply when NOLs are carried forward from a separate return year onto a consolidated return
Consolidated return can include loss from member’s SRLY period only to lesser of its:
Current year income, or
Cumulative positive contribution to current year consolidated income

45. Computation of Group Items (slide 1 of 2)
Several items are computed on a consolidated basis including:
Net capital gain/loss
§ 1231 gain/loss
§ 199 domestic production activities deduction
Casualty/theft gain/loss
Charitable contributions
Dividends received deduction
Net operating loss
AMT adjustments and preferences

46. Computation of Group Items (slide 2 of 2)
Several items are computed on a consolidated basis (cont’d)
All of these items are removed from members’ separate taxable income
Then use consolidated taxable income to that point to determine statutory limitations for group-basis gains, losses, income, and deductions

47. The Matching Rule (slide 1 of 3)
Certain intercompany transactions receive deferral treatment
Gain or loss realized is removed from taxable income until the sold asset leaves the group
Prevents accelerating loss deductions on sales of assets within the group

48. The Matching Rule (slide 2 of 3)
Certain intercompany transactions receive deferral treatment (cont’d)
Applies to the following transactions among group members:
Sale of assets
Performance of services

49. The Matching Rule (slide 3 of 3)
The entire deferred gain or loss is included in consolidated taxable income when:
The asset is transferred outside the group
The transferor of property leaves the group
Consolidation election is terminated

50. Dr. Donald R. Trippeer, CPA
If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:
Dr. Donald R. Trippeer, CPA
SUNY Oneonta