1. Life Nonlife Consolidated Returns:
The tacking rule and other issues
American Bar Association
2015 Midyear Meeting
Insurance Companies Committee
Houston, TX
January 30, 2015
Christopher W. Schoen, Sutherland, Asbill & Brennan LLP, moderator
Mark J. Cavanaugh, State Farm Insurance Companies
Gerald B. Fleming, Senior Technician Reviewer, Associate Chief Counsel (Corporate)

2. Statutory Background
Section 1504(b)(2) provides the general rule that life insurance companies are not treated as “includible corporations” and thus cannot join in the filing of a consolidated return.
Section 1504(c)(2), however, provides an exception, whereby if an affiliated group includes one or more life insurance companies (“life companies”), the common parent of the affiliated group may elect to treat all such companies as includible corporations, with certain restrictions. The most significant restrictions include the following:
No life company may join the group unless it has been a member of the affiliated group for the five preceding taxable years prior to the filing of the consolidated return.
The use of the losses of nonlife companies by life companies is limited.

3. Treas. Reg. §
Treas. Reg. § provide the rules for the making of a life-nonlife election and the calculation of the tax liability of life-nonlife groups.
The regulations adopt a broad reading of the statutory rules and arguably considerably expand the restrictions contained in section 1503(c) and 1504(c) of the Code.
The regulations create the concept of eligibility for both life and nonlife companies, as discussed below.
The regulations separate the members into life and nonlife subgroups that must separately calculate items of income, gain, deduction, and loss. The cross-application of tax items between the subgroups is only permitted in limited circumstances.

4. Eligibility Requirements
A corporation is an eligible corporation for a taxable year of a group only if, throughout every day of the base period (the common parent’s five taxable years immediately preceding the group’s taxable year for which the consolidated return and the determination of eligibility are made), the corporation:
Was in existence and a member of the group (determined without the exclusions in section 1504(b)(2));
Was engaged in the active conduct of a trade or business;
Did not experience a change in tax character (i.e., was taxed under section 11, 801 or 831); and
Did not undergo a disproportionate asset acquisition.

5. Tacking Requirements
The tacking rule is an exception to the general eligibility rule in situations where a “new corporation” is formed from another eligible corporation (an “old corporation”). Four conditions must be met:
At any time, 80 percent or more of the new corporation’s assets were acquired from the old corporation in one or more transactions described in section 351(a) or 381(a);
At the end of the taxable year during which the first condition is first met, the old corporation and the new corporation must have the same tax character;
At the end of the taxable year during which the first condition is first met, the new corporation does not undergo a disproportionate asset acquisition; and
If there is more than one old corporation, the first two conditions must be met by all of the old corporations.
If the tacking rule is met, the new corporation “tacks” the parent’s period of existence and active business for purposes of meeting the eligibility requirements.

6. TAM
Holding
1. $X
2. $Y
Newco
Life
3. Employees

7. TAM 9816001: Facts and Issue FACTS:
In Year 1, Holding forms Newco, a nonlife company, by transferring $X in exchange for all of Newco’s stock in a section 351 transaction.
In Year 2, Holding transfers an additional $Y to Newco in constructive exchange for additional Newco stock.
Later in Year 2, certain employees of Life become employed by Newco. Still later, an entire division of Life moves to Newco. The employees appear to perform back office functions, such as accounting and human resources functions. Life pays Newco on a cost reimbursement basis for the value of the back office employees.
Newco sustained losses in Year 2 and Year 3. The Holding Group applies those losses to offset life income, which would not be permitted unless Newco is an eligible member of the Life-Nonlife group.
Issue:
Is Newco an eligible nonlife company in the Holding group?

8. TAM 9816001: Active Trade or Business
The IRS agent asserted that the tacking rule could not be met in this case since the only asset transferred by Holding into Newco was cash. The Agent argued the tacking rules implicitly require the old corporation to transfer a business to the new corporation for the new corporation to meet the tacking rule.
The IRS National Office concluded that:
The rules do not explicitly or implicitly require that the old corporation transfer a business into the new corporation. Accordingly, the fact that Holding only transferred cash does not prevent the tacking rule from having been met.
As long as Newco did nothing other than hold cash, it did not meet the active business requirement. However, at some point during Year 2, Newco appears to have become involved in providing services to the other members of the Holding group. At that point, it was appropriate to test to determine if the Newco had met the tacking requirement.

9. TAM 9816001:80 Percent Test for Tacking
Does the transfer of employees constitute an intangible asset that must be taken into account for purposes of the 80 percent test?
If so, does this constitute the transfer of an asset from a life company, workforce-in-place, which has a different tax character than Newco?
If so, why even consider the transfer, since the transfer of the employees does not occur until Year 2?
Does the step transaction doctrine apply here?
Should the transfer be treated as if the intangible was transferred from Life to Holding and then to Newco? What would the consequences be of such a determination?

10. Tacking for licensed shell corporation PLR 201210015
Year 1:
LifeCo transfers 2x cash to Sub
End of Year – Sub holds life license but has written no business and holds no life reserves (i.e., Sub is a nonlife company)
Years 2-9:
Sub not engaged in active business, holds only assets received from LifeCo and income thereon
Year 10:
LifeCo transfers to Sub 18x in cash and securities
End of year – Sub actively writing business giving rise to life reserves
Problem:
Sub not engaged in an active trade or business in years 1 through 9, during which time it was not an eligible corporation (i.e., any losses of Sub could not be used to offset income of LifeCo)
Absent tacking, Sub would not be an eligible member per -47(d)(12)(v)(B) until Year 16

11. Tacking Rule tests met in Year 10?
80% of assets acquired from old corporation?
Yes, 18x of 20x assets acquired in Year 10
Disproportionate asset acquisition or multiple old corporations?
No and no
Do LifeCo and Sub have same tax character?
Per -47(d)(12)(vii), the no character change rule normally applies only if the character change occurs due to acquisition of assets from outside group. However, if a corporation is relying on the tacking rule, the no character change rule must be satisfied even if assets acquired from within the group.
Both are life companies at end of year 10 (a year in which at least 80% of its assets were acquired from LifeCo)
But at the end of the very first year in which Sub had received 80% of its assets from LifeCo (Year 1) LifeCo and Sub had different tax character

12. Reg. § (d)(12)(v)(B)
“The second condition is that at the end of the taxable year during which the first condition [i.e., the “new corporation” receives at least 80% of its assets from the “old corporation”] is first met, the old corporation and the new corporation must have the same tax character”
Even though Year 10 is not the year in which the 80% test was first met, it was the first year in which the tacking rule could be relied upon in order to permit Sub to be an eligible member
IRS ruled that Sub is an eligible life company in Year 10
IRS seems to be applying the tacking rule by treating Sub as a “new corporation” in Year 10 but not Year 1. If Sub is a new corporation in Year 10 but not Year 1, then Year 10 is the first year that Sub, as a new corporation, received 80% of its assets from the old corporation.
Change facts: What if Sub received only 4x assets from LifeCo in Year 10, so that it received only 66% of its assets from old corporation in Year 10?
Change facts: Sub is engaged in a short-term disability business in Years 2 through 9. In Year 10, Lifeco contributes assets into Newco that represent more than 80 percent of the total value of Newco. Newco commences writing noncancellable accident and health policies. At the end of Year 10, more than 50 percent of Newco’s total reserves are attributable to the noncancellable accident and health business.

13. PLR
Taxpayer is the common parent of a life-nonlife consolidated group.
In Year 1, Sub 1 acquired all of the stock of Sub 2 and its affiliates, including Sub 3, a life company. Sub 3 has not issued new policies since Year Y, but the taxpayer anticipates that it will take Sub 3 at least z years to run off its existing policies.
The ruling redacts the number of years to run off the policies, but it is safe to say, assuming the company sold life insurance policies, that it would likely take in excess of 25 years to run off all of the policies.
The ruling appears to be requested five years after the acquisition of Sub 3, when the eligibility of Sub 3 would likely be met if the active business test is met.
The taxpayer requested a ruling that Sub 3 was engaged in the active conduct of a trade or business, and therefore was an eligible corporation.
Although “active conduct” is not defined for purposes of life-nonlife rules, practitioners have long believed that the active business test for purposes of the life-nonlife rules is the same as the test found in sections 355 and 367 of the Code.

14. PLR (con’t)
The IRS ruled that “Sub 3 has been engaged in the active conduct of a trade or business within the meaning of Treas. Reg. § (d)(12)(i)(B).”
IRS specifically included a caveat that no opinion is expressed about the tax treatment of Sub 3 under other provisions of the Code.
Query whether IRS meant that this caveat implies that the corporation does not necessarily meet the active business requirement under sections 355 and Is the standard therefore different (easier) for life-nonlife purposes than, say, for section 355 purposes? Cf. Prop. Reg. §  (b)(1)(iii)—is this runoff company the principal owner of the goodwill of the trade or business?
IRS also included a caveat with respect to whether the corporation qualified as a life company. Not clear of the scope or purpose for this caveat.

15. The 80 Percent Test: Example for Discussion
Partnership owns Holding, the common parent of a life-nonlife group, which includes Lifeco.
In 2007 through 2009, Lifeco experienced large losses on investments. Partnership, possibly at the insistence of state regulator, requires Partnership to contribute cash through Holding and into Lifeco to increase Lifeco’s RBC ratio. The contribution serves to approximately double Lifeco’s surplus.
In 2011, Lifeco capitalizes a newly formed subsidiary with the intent of utilizing the subsidiary to sell a new product. All of the subsidiary’s assets are contributed from Lifeco.

16. The 80 Percent Test: Example for Discussion (cont.)
Issue: Does the subsidiary meet the tacking requirement?
Rule: Assets acquired from outside the group in transactions not conducted in the ordinary course of its trade or business are not included in the 80 percent (but are included in total assets) if the old corporation acquired those assets within five calendar years before the date of their transfer to the new corporation.
How does one account for contributions of cash under this rule, since cash is fungible? Does the transfer to the new corporation all come out of surplus or does it come out of total assets?
Does Lifeco acquire the assets from outside the group or from Holding?
Is the capitalization of Lifeco by the Partnership outside the ordinary course of business?
Even though the Partnership is not part of the group, should it really be considered a contribution from outside the group, since the Partnership is a related party and the purpose of the rule doesn’t appear to be violated? See Treas. Reg. § (d)(12)(viii)(E) (Money contributed to a corporation by a shareholder that is not a member of the group (without section 1504(b)(2)) is not a special acquisition).

17. Consolidated Charitable Contributions TAM 200323002
IRS ruled that charitable contribution deduction limitation must be calculated on subgroup basis
Under § , a group contribution limitation is calculated by aggregating separate company incomes calculated before charitable contributions, before DRD, before consolidated NOLs and before consolidated capital loss
-47(h) states consolidated return regulations (which of course include -24) are applied on a subgroup basis
-47(r) states that the life-nonlife rules preempt any other consolidated return regulation

18. Nonlife Subgroup -24(c) income = 100 Nonlife Charitable Contributions = 5 Life Subgroup -24(c) Income = 50 Life Charitable Contributions = 10
Taxpayer Calculation
IRS Calculation
Step 1 – add subgroups’ -24(c) incomes ( = 150) Step 2 – calculate limitation as 10% of this amount (15) Step 3 – allocate this 15 limit to each subgroup based on relative share of total contributions (i.e, 5 to nonlife group and 10 to life group) Result: Since neither subgroup has charitable contributions in excess of its limit, total allowed charitable contribution is 15.
Calculate each subgroup’s limitations as 10% of each group’s -24(c) income (Nonlife = 10 and Life = 5) Result: Life subgroup has contributions of 10 but a limit of 5. Total consolidated charitable contribution allowed is 10.

19. What is the statutory basis for this result?
While the TAM may be a correct reading of the consolidated return regulations, is the calculation of the charitable contribution limitation on a subgroup basis required by the Code?
-47(h) and(r), by requiring the charitable contribution limitation to be calculated on a subgroup basis, can restrict the use of charitable contributions in a year in which both subgroups have net income
Per -47(a)(3), the statutory authority for the -47 regs are §§1502, 1503(c) (loss limitation rule), 1504(c)(2) (base period rule) and 7805(b) (general authority to prescribe all needful rules)
§1502 – “The Secretary shall prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations making a consolidated return .. . may be [determined] in such a manner as to clearly reflect the income tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance of such liability.”

20. Loss Limitation Rule Preserved in §332 Liquidation PLR 9029030
Facts:
LifeCo is the parent of a life-nonlife group; LifeCo owns a chain of nonlife subsidiaries
In a series of §332 liquidations, the non-life subs were liquidated up and into LifeCo
Rulings:
NOLs of liquidated subs carry over to LifeCo per §381(c)
NOLs retain character as nonlife losses – losses may be used without limitation to offset nonlife income but are subject to the 35% limitation when offsetting life income