1. 8-1 ©2008 Prentice Hall, Inc.

2. 8-2 ©2008 Prentice Hall, Inc. CONSOLIDATIONS (1 of 3)  Source of consolidated tax return rules  Affiliated groups  Advantages & disadvantages of consolidating  Consolidated taxable income  Affiliated group’s tax liability

3. 8-3 ©2008 Prentice Hall, Inc. CONSOLIDATIONS (2 of 3)  Intercompany transactions  Dividends received by group members  Consolidated charitable contributions  Consolidated U.S. production activities deduction  Net operating losses (NOLs)

4. 8-4 ©2008 Prentice Hall, Inc. CONSOLIDATIONS (3 of 3)  Consolidated Capital gains and losses  Other consolidated items  Stock basis adjustments  Financial statement implications

5. 8-5 ©2008 Prentice Hall, Inc. Source of Consolidated Tax Return Rules  §§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

6. 8-6 ©2008 Prentice Hall, Inc. 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

7. 8-7 ©2008 Prentice Hall, Inc. 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

8. 8-8 ©2008 Prentice Hall, Inc. 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

9. 8-9 ©2008 Prentice Hall, Inc. 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

10. 8-10 ©2008 Prentice Hall, Inc. 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

11. 8-11 ©2008 Prentice Hall, Inc. 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. Eliminate any item that is reported on a consolidated basis  Resulting amount is separate taxable income

12. 8-12 ©2008 Prentice Hall, Inc. 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 C8-1

13. 8-13 ©2008 Prentice Hall, Inc. Consolidated Taxable Income Affiliated Group Elections  Tax years  Consolidated return must parent’s tax year  Methods of accounting  Each group member’s method used for separate filing is used for consolidated return

14. 8-14 ©2008 Prentice Hall, Inc. Affiliated Group Tax Liability 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

15. 8-15 ©2008 Prentice Hall, Inc. Affiliated Group Tax Liability Regular Tax Liability (2 of 2)  Affiliated groups may claim all tax credits available to corporations  Determined on a consolidated basis

16. 8-16 ©2008 Prentice Hall, Inc. Affiliated Group Tax Liability Alternative Minimum Tax  AMT prepared on a consolidated basis for all group members  Computation parallels determination of group’s consolidated taxable income

17. 8-17 ©2008 Prentice Hall, Inc. Intercompany Transactions (1 of 2)  Transactions between corporations that are members of the same affiliated group immediately after the transaction

18. 8-18 ©2008 Prentice Hall, Inc. Intercompany Transactions (2 of 2)  Examples include:  Property transactions  Other intercompany transactions  Performance of services  Licensing of technology  Renting of property  Lending of money  Payment of a dividend to a parent

19. 8-19 ©2008 Prentice Hall, Inc. 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

20. 8-20 ©2008 Prentice Hall, Inc. Property Transactions (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

21. 8-21 ©2008 Prentice Hall, Inc. 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

22. 8-22 ©2008 Prentice Hall, Inc. Dividends Received by Group Members  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

23. 8-23 ©2008 Prentice Hall, Inc. 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

24. 8-24 ©2008 Prentice Hall, Inc. Consolidated 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

25. 8-25 ©2008 Prentice Hall, Inc. Consolidated 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.

26. 8-26 ©2008 Prentice Hall, Inc. Consolidated 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

27. 8-27 ©2008 Prentice Hall, Inc. Consolidated NOLs  Current year NOLs  Carryovers of consolidated NOLs  Carryback to separate return year  Carryforward to separate return year  Special loss limitations

28. 8-28 ©2008 Prentice Hall, Inc. Current Year NOLs  All members’ income/losses combined  Loss from one member offsets income from another member  Carrybacks and carryforwards done on consolidated basis if group has not changed its members  Carryback 2 yrs and forward 20 years

29. 8-29 ©2008 Prentice Hall, Inc. Carryovers of Consolidated NOLs Separate taxable income of each group member +Consolidated capital gain net income -Consolidated §1231 net loss -Consolidated charitable contrib deduction -Consolidated dividends received deduction Consolidated NOL

30. 8-30 ©2008 Prentice Hall, Inc. Carryback NOL to Separate Return Year Separate NOL of the individual member ∑ separate NOLs of all members having NOLs Consolidated NOL Portion of consolidated NOL attributable to member X =

31. 8-31 ©2008 Prentice Hall, Inc. Carryforward NOL to Separate Return Year  If corporation leaves the affiliated group, the departing corp takes its share of consolidated NOL with it

32. 8-32 ©2008 Prentice Hall, Inc. 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 limitations

33. 8-33 ©2008 Prentice Hall, Inc. 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

34. 8-34 ©2008 Prentice Hall, Inc. 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

35. 8-35 ©2008 Prentice Hall, Inc. 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

36. 8-36 ©2008 Prentice Hall, Inc. 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

37. 8-37 ©2008 Prentice Hall, Inc. 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

38. 8-38 ©2008 Prentice Hall, Inc. 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

39. 8-39 ©2008 Prentice Hall, Inc. 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 C8-34 and C8-35

40. 8-40 ©2008 Prentice Hall, Inc. 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

41. 8-41 ©2008 Prentice Hall, Inc. 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

42. 8-42 ©2008 Prentice Hall, Inc. 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

43. 8-43 ©2008 Prentice Hall, Inc. Financial Statement Implications SRLY Losses  NOL from SRLY creates deferred tax asset  Possibly subject to a valuation allowance

44. 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 8-44 ©2008 Prentice Hall, Inc.