1. 8-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

2. 8-2 CONSOLIDATIONS (1 of 2)  Affiliated groups  Consolidated tax return election  Consolidated taxable income  Intercompany transactions  Items computed on a consolidated basis  Net operating losses (NOLs) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

3. 8-3 CONSOLIDATIONS (2 of 2)  Stock basis adjustments  Tax planning considerations  Compliance and procedural considerations  Financial statement implications ©2011 Pearson Education, Inc. Publishing as Prentice Hall

4. 8-4 Affiliated Groups Stock Ownership Requirement  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

5. 8-5 Affiliated Groups Excluded Corporations  Tax exempts under §501  Insurance companies under §801  Foreign corporations  May elect to treat 100% owned Canadian or Mexican corp as domestic  Regulated investment companies  Real estate investment trusts  S corporations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

6. 8-6 Affiliated Groups Comparison with Controlled Group Definitions (1 of 2)  Brother-sister controlled groups cannot file consolidated returns  Parent-subsidiary controlled groups and parent-subsidiary portion of combined controlled groups can file consolidated returns ©2011 Pearson Education, Inc. Publishing as Prentice Hall

7. 8-7 Affiliated Groups Comparison with Controlled Group Definitions (2 of 2)  Differences between rules  Stock ownership for affiliated group is ≥80% of voting power AND value  Attribution rules more strict for affiliated groups  Excluded corporations differ  Affiliated group definition tests done on each day of the year, not just 12/31 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8. 8-8 Consolidated Tax Return Election (1 of 2)  §§1501-1504  Very general  Primarily define affiliated groups eligible to file consolidated return  Statutory and interpretative Regs used to determine consolidated tax liability and filing requirements ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9. 8-9 Consolidated Tax Return Election (2 of 2)  Termination of consolidated filing  Termination of affiliated group  Good cause request to discontinue  Effects of former members  Gains and losses deferred on intercompany transactions may have to be recognized under acceleration rule  Consolidated return attributes must be allocated among former group members ©2011 Pearson Education, Inc. Publishing as Prentice Hall

10. 8-10 Consolidated Taxable Income Accounting Periods and Methods  Accounting periods  Consolidated return must conform to parent’s tax year  Accounting methods  Each group member’s method used for separate filing is used for consolidated return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

11. 8-11 Consolidated Taxable Income Calculation (1 of 2) 1. Compute each member’s income 2. Adjust each member’s income  Adjustments made to take into account special consolidated treatment 3. Remove any item that is reported on a consolidated basis  Resulting amount is separate taxable income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

12. 8-12 Consolidated Taxable Income Calculation (2 of 2) 4. Combine separate taxable income (STI) of each member  Resulting amount is combined TI 5. Adjust combined taxable income for items reported on a consolidated basis  Resulting amount is consolidated taxable income (or NOL) See Table 1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

13. 8-13 Intercompany Transactions (1 of 3)  Transactions between corporations that are members of the same affiliated group immediately after the transaction  Matching rule  Consolidated group treats intercompany item as if both companies were divisions of a single company ©2011 Pearson Education, Inc. Publishing as Prentice Hall

14. 8-14 Intercompany Transactions (2 of 3)  Acceleration rule  When a member leaves the group, any transaction involving the departing member is fully taken into account ©2011 Pearson Education, Inc. Publishing as Prentice Hall

15. 8-15 Intercompany Transactions (3 of 3)  Examples include:  Property transactions  Performance of services  Licensing of technology  Renting of property  Lending of money  Subsidiary’s distribution to parent  Dividend or redemption ©2011 Pearson Education, Inc. Publishing as Prentice Hall

16. 8-16 Property Transactions (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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

17. 8-17 Property Transactions (2 of 2)  Examples of recognition events:  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

18. 8-18 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

19. 8-19 Items Computed on a Consolidated Basis (1 of 2)  Charitable contribution deduction  Net §1231 gain or loss  Capital gains and losses  Dividends received deduction  U.S. production activities deduction ©2011 Pearson Education, Inc. Publishing as Prentice Hall

20. 8-20 Items Computed on a Consolidated Basis (2 of 2)  Regular tax liability  AMT liability  Tax credits  Estimated tax payments ©2011 Pearson Education, Inc. Publishing as Prentice Hall

21. 8-21 Charitable Contribution Deduction  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

22. 8-22 Capital Gains and Losses  Determined in manner similar as for single corporation  Departing members’ capital losses  Rules similar to NOL treatment  Departing member allocated a portion of capital loss carryover  SRLY limitation for carrybacks from separate return year ©2011 Pearson Education, Inc. Publishing as Prentice Hall

23. 8-23 Dividends Received Deduction  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

24. 8-24 U.S. Production Activities Deduction (1 of 3)  The affiliated group’s U.S. production activities deduction (CPAD) is computed on a consolidated basis  Lesser of  Consolidated productive activities income OR  Consolidated taxable income before CPAD deduction ©2011 Pearson Education, Inc. Publishing as Prentice Hall

25. 8-25 U.S. Production Activities Deduction (2 of 3)  For purposes of computing CPAD, definition of affiliated group stock ownership threshold is 50% instead of 80%  Lower threshold may require inclusion of corps in this deduction that are not part of the consolidated return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

26. 8-26 U.S. Production Activities Deduction (3 of 3)  Production activities income computed on consolidated basis and then deduction allocated to corps based on relative amount of qualified production activities income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

27. 8-27 Regular Tax Liability  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

28. 8-28 Corporate AMT Liability  AMT prepared on a consolidated basis for all group members  Computation parallels determination of group’s consolidated taxable income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

29. 8-29 Tax Credits  Affiliated groups may claim all tax credits available to corporations  Determined on a consolidated basis ©2011 Pearson Education, Inc. Publishing as Prentice Hall

30. 8-30 Estimated Payments  1 st two years option to make on separate or consolidated basis  After 2 nd year must be on consolidated basis ©2011 Pearson Education, Inc. Publishing as Prentice Hall

31. 8-31 Consolidated NOLs  Current year NOLs  Carryovers of consolidated NOLs  Carryback to separate return year  Carryforward to separate return year  Special loss limitations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

32. 8-32 Current Year NOLs (1 of 2)  All members’ income/losses combined  Loss from one member offsets income from another member ©2011 Pearson Education, Inc. Publishing as Prentice Hall

33. 8-33 Current Year NOLs (1 of 2)  Carrybacks and carryforwards done on consolidated basis if group has not changed its members  Carryback 2 yrs and forward 20 years  Taxpayer can elect to carryback NOL from 2008 or 2009 3, 4, or 5 years ©2011 Pearson Education, Inc. Publishing as Prentice Hall

34. 8-34 NOL Carrybacks and Carryovers NOL Allocated to Members with Separate Loss ©2011 Pearson Education, Inc. Publishing as Prentice Hall Separate NOL of member ___________ Sum of all separate NOLs Consolidated NOL X = Portion of consolidated NOL attributable to member

35. 8-35 NOL Carrybacks and Carryovers NOL Carryforwards  If corporation leaves the affiliated group, the departing corp takes its share of consolidated NOL with it ©2011 Pearson Education, Inc. Publishing as Prentice Hall

36. 8-36 Special Loss Limitations SRLY (1 of 3)  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 SRLY limitations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

37. 8-37 Special Loss Limitations SRLY (2 of 3)  NOL allocable to departing member becomes member’s separate CF only after all available carryovers are absorbed in current consolidated return year  NOL CF incurred in SRLY lesser of  Loss member’s income, gain, deduction, and loss minus NOLs previously absorbed for all consolidated return years of group,  Consolidated taxable income, or  Amount of the NOL carryover ©2011 Pearson Education, Inc. Publishing as Prentice Hall

38. 8-38 Special Loss Limitations SRLY (3 of 3)  SRLY carryover cannot be used when member’s cumulative contribution < $0  SRLY rules also apply to carrybacks for corporations who leave group and later carryback NOLs to consolidated years  In a reverse acquisition, SRLY limitation applies the acquiring corp’s NOLs ©2011 Pearson Education, Inc. Publishing as Prentice Hall

39. 8-39 Special Loss Limitations §382 (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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

40. 8-40 Special Loss Limitations §382 (2 of 2)  Loss limitation  Value of loss group x federal interest rate  Loss group value is value of all common & pref stock owned by outsiders immediately before change of ownership  SRLY NOL creates deferred tax asset  May be subject to a valuation allowance ©2011 Pearson Education, Inc. Publishing as Prentice Hall

41. 8-41 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  Adjustments listed on page 35 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

42. 8-42 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

43. 8-43 Tax Planning Considerations Advantages of Consolidating (1 of 2)  Losses in one member offset gains in another in the current year  Intragroup dividends are eliminated  Combined credits and deductions may avoid carryovers  Intragroup gains are deferred  Consolidated AMT may reduce the negative effects of AMT adjustments ©2011 Pearson Education, Inc. Publishing as Prentice Hall

44. 8-44 Tax Planning Considerations Advantages of Consolidating (2 of 2)  Parent corp (& upper tier corps) increase its bases in subsidiary stock investments for sub’s taxable income, eliminating double taxation ©2011 Pearson Education, Inc. Publishing as Prentice Hall

45. 8-45 Tax Planning Considerations Disadvantages of Consolidating  Election binding on subsequent years  Members must use same tax year  Intragroup losses are deferred  Intragroup losses may reduces the limitation on certain deductions and credits  Additional administrative cost ©2011 Pearson Education, Inc. Publishing as Prentice Hall

46. 8-46 Compliance and Procedural Considerations (1 of 2)  Basic election and return  File Form 1120  Including Form 851 affiliations schedule  Subs’ consent to election use Form 1122  Must provide a columnar schedule reconciling consolidated income with members’ separate incomes ©2011 Pearson Education, Inc. Publishing as Prentice Hall

47. 8-47 Compliance and Procedural Considerations (1 of 2)  Parent corp acts as agent for group  Parent can request IRS consent to treat intercompany transactions on a separate entity basis  Tax treatment of affiliated groups for state income tax purposes of varies from state to state ©2011 Pearson Education, Inc. Publishing as Prentice Hall

48. 8-48 Financial Statement Implications Intercompany Transactions (1 of 2)  Discussion based on 100%-owned sub  Intercompany dividends  Eliminated for both tax and book whether filing separately or consolidated  Intercompany sales  Defers intercompany income for book and tax if filing consolidated return  Deferred amounts may differ ©2011 Pearson Education, Inc. Publishing as Prentice Hall

49. 8-49 Financial Statement Implications Intercompany Transactions (2 of 2)  Intercompany sales (continued)  If filing separate returns  Seller recognizes income for tax purposes, but not for financial stmt purposes  Group recognizes deferred tax asset on difference between profit deferred in consolidated financial stmts and taxes paid on seller’s separate tax return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

50. 8-50 Financial Statement Implications SRLY Losses  NOL from SRLY creates deferred tax asset  Possibly subject to a valuation allowance ©2011 Pearson Education, Inc. Publishing as Prentice Hall

51. 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 8-51 ©2011 Pearson Education, Inc. Publishing as Prentice Hall