Chapter 8 - Consolidated Tax Return

Question 1

What are nontax considerations for combining corporations?

Answer 1

• Succession and estate planning goals
• Protection of corporate brands by obscuring ownership of subsidiaries that generate negative publicity
• Easier to sell, transfer, or move a business line
• Isolate assets of high-risk affiliates (limit liability exposure)
• If managers believe that the stock market cannot accurately value commingled assets, separate group members may be worth more if they maintain separate identities

Question 2

Consolidated Returns

Answer 2

A procedure whereby certain affiliated corporations may file a single return, combine the tax transactions of each corporation, and arrive at a single income tax liability for the group. The election to file a consolidated return usually is binding on future years. §§ 1501–1505 and related Regulations.

Question 3

What are the two goals for consolidated return rules (Congress and Treasury Department)?

Answer 3

1. Treat certain corporate groups as a single entity to the extent possible
2. Limit/eliminate incentives to purchase another corporation to acquire its tax attributes like NOLs, capital losses, and tax credits

Question 4

The consolidated return rules may be available to a taxpayer as a result of various business decisions:

Answer 4

• Merger, acquisition, or other corporate combination
• A group of business taxpayers may be restructured to comply with changes in regulatory requirements, meet the demands of a competitive environment, or gain economies of scale and operate more efficiently in a larger form.
• The taxpayers may be seeking to gain tax, financial reporting, and other economic advantages that are more readily available to corporate combinations.

Question 5

What are tax advantages for group members filing consolidated returns?

Answer 5

1. Elimination of all intercompany dividends from consolidated taxable income.
2. Use of shares held by all group members to meet certain other statutory requirements.
3. The ability of group members to offset income with losses from other members. This applies to operating, capital, and other losses.

Question 6

What are tax disadvantages for group members filing consolidated returns?

Answer 6

1. The election to consolidate is binding on the group members for future tax years unless a group member leaves the group (in which case the election is still binding on the remaining members) or the IRS consents to an election revocation.
2. The requirement that all group members use the parent’s tax year may create short tax periods for subsidiaries when they join the group.
3. Consolidated groups incur additional administrative costs in computing consolidated tax liabilities and in complying with the consolidated return Regulations generally.

Question 7

What are tax considerations that could be advantageous or disadvantageous, depending on the situation?

Answer 7

1. Certain consolidated deductions and credits can be either higher or lower due to using consolidated limitations instead of the separate company limits.
2. The tax basis of investments in the stock of subsidiaries increases by the members’ contribution to consolidated taxable income, perhaps reducing future investor gains. Conversely, subsidiary tax basis decreases by the member’s operating losses and by dividend distributions the member makes to its shareholder/parent. Thus, the basis that parent corporations have in their subsidiaries can be either higher or lower than the original purchase prices.
3. The consolidated group must defer recognizing gains and losses arising from intercompany property sales. Ordinarily, this is an advantage when deferring gains and a disadvantage when deferring losses.

Question 8

A corporation can join in a consolidated tax return if it meets three requirements:

Answer 8

1. It is a member of an affiliated group.
2. It is not ineligible to file on a consolidated basis.
3. It meets the initial and ongoing compliance requirements specified in the Code and Regulations.

Question 9

Affiliated Group

Answer 9

A parent-subsidiary group of corporations that is eligible to elect to file on a consolidated basis. 80% ownership of the voting power and value of all of the corporations must be achieved every day of the tax year, and an identifiable parent corporation must exist (i.e., it must own at least 80% of another group member without applying attribution rules). § 1504(a).

Question 10

Members of an affiliated group can file tax returns in either of two ways:

Answer 10

1. File a separate tax return for each member of the group, and claim a 100% dividends received deduction for payments passing among them.Footnote
2. Elect to file income tax returns on a consolidated basis for two or more of the affiliates. No 100%dividends received deduction is allowed for payments among group members, but consolidated returns disregard dividends to other group members.

Question 11

Controlled Group

Answer 11

Controlled groups include parent-subsidiary groups, brother-sister groups, combined groups, and certain insurance companies. Controlled groups are required to share certain elements of tax calculations or tax credits. §§ 1561 and 1563.

Question 12

Members of a controlled group must defer the recognition of any realized loss on intercompany sales until…

Answer 12

A sale is made at a gain to a nongroup member

Question 13

Any gain on the sale of depreciable property between members of a controlled group is recognized as…

Answer 13

ordinary income

Question 14

What corporations may not use a consolidated return to report their taxable income, cannot be used to meet the stock ownership tests, and their taxable incomes cannot be included in a consolidated return?

Answer 14

1. Corporations established outside the United States or in a U.S. possession.
2. Tax-exempt corporations.
3. Insurance companies.
4. Partnerships, trusts, estates, limited liability entities, and other noncorporate entities.

Question 15

What requirements must the first consolidated tax return of an affiliated group meet?

Answer 15

1. Form 1120 includes the taxable results of the operations of all group members. Members do not file their own returns. The identified group continues to file on a consolidated basis until they de-consolidate.
2. Form 1122 should be attatched to the first consolidated tax return for each of the subsidiaries included in the group.
3. The consolidation election must be made no later than the extended due date of the partent’s return for the year.

Question 16

An application to terminate the consolidation election must be filed at least __ days prior to the extended due date of the consolidated return.

Answer 16

90

Question 17

Generally, when a subsidiary leaves an ongoing consolidated group, it must wait __ years before it can reenter the same parent’s consolidated group.

Answer 17

5

Question 18

851 Affiliations Schedule

Answer 18

This report identifies all of the corporations in the electing group, summarizes pertinent shareholdings and stock ownership changes that occurred during the tax year, and lists the estimated tax payments made by the group members for the year.

Question 19

When are consolidated tax returns due?

Answer 19

15th day of the 4th month following the close of the group’s tax year (usually April 15th for calendar year taxpayer)

Question 20

Form 7004

Answer 20

Consolidated taxpayers can obtain a 6 month extension using this form, but an estimated payment of the remaining tax liability for the group must accompany the extension application

Question 21

How are group members liabile for the entire consolidated income tax liability?

Answer 21

jointly and severally liable

Question 22

The group must pay estimated tax on consolidated income starting with the ___ consolidated return year. Prior to that year, estimates can be computed and paid on either a ______ or ______ basis.

Answer 22

3rd.
Separate or Consolidated

Question 23

Treasury Regulations sanction two methods for sharing consolidated tax liabilities:

Answer 23

the relative taxable income and relative tax liability methods.

Question 24

Relative Taxable Income Method

Answer 24

The consolidated tax liability is allocated among the members based on their relative amounts of separate taxable income.

Question 25

Relative Tax Liability Method

Answer 25

The consolidated tax liability is allocated based on the relative hypothetical separate tax liabilities of the members.

Question 26

Do all members of a consolidating group have to use the parent’s tax year?

Answer 26

Yes

Question 27

What tax accounting methods are used by the members of a consolidated group?

Answer 27

The method that was in place prior to the consolidation election (members of a consolidated group may use different accounting methods)

Question 28

Group members must perform the _______ ________ test for using the cash method of accounting using consolidated numbers, so some group members may fail the test after consolidation and need to switch from the ______ to the ______ method of tax accounting.

Answer 28

Gross Receipts
Cash to Accrual

Question 29

An acquiring parent corporation records a subsidiary stock basis on its tax balance sheet equal to…

Answer 29

the cost of the stock

Question 30

Unlike most taxpayers, the acquiring parent corporation must…

Answer 30

adjust its basis in the subsidiary stock in a procedure that is similar to the equity method of financial accounting

Question 31

Why does the parent have to adjust its stock basis?

Answer 31

To prevent double taxation of gain if the parent later sells the subsidiary’s shares

Question 32

Positive adjustments to the subsidiary stock basis for the parent

Answer 32

1. An allocable share of consolidated taxable income for the year.
2. An allocable share of the consolidated operating or capital loss of a subsidiary that could not utilize the loss through a carryback to a prior year.

Question 33

Negative adjustments to the subsidiary stock basis for the parent

Answer 33

1. An allocable share of a consolidated taxable loss for the year.
2. An allocable share of any carryover operating or capital losses that are deducted on the consolidated return and have not previously reduced stock basis.
3. Dividends paid by the subsidiary to the parent (i.e., distributions from the subsidiary’s E & P).

Question 34

When accumulated postacquisition negative adjustments to the stock basis of the subsidiary exceed the acquisition price plus prior positive adjustments, the stock basis becomes…

Answer 34

zero and an excess loss account is created

Question 35

Excess loss account

Answer 35

This treatment allows the parent to continue to deduct losses of the subsidiary, even where no basis reduction is possible, while avoiding the need to show a negative stock basis on various financial records. If the subsidiary stock is sold while an excess loss account exists, capital gain income usually is recognized to the extent of the balance in the account.

Question 36

If the parent deconsolidates, redeems the subsidiary stock, or sells it to a nongroup member, the seller must increase the recognized gain on the transaction by the amount of…

Answer 36

the excess loss account

Question 37

There is no such concept as consolidated E&P, rather…

Answer 37

each entity accounts for its own share of consolidated taxable income on an annual basis, immediately recognizing within E & P any gain or loss on intercompany transactions and reducing E & P by an allocable share of the consolidated tax liability

Question 38

What are the steps to calculating consolidated taxable income?

Answer 38

1. Compute each group member’s taxable income separately.
2. Remove all “group items” and some “intercompany items” from the aggregate separate taxable income amounts. Adjust these items for the special treatment that the consolidation rules require.
3. Combine the remaining separate company incomes with the adjusted intercompany items. Use this amount to compute group item limits and final amounts. The result is consolidated taxable income.

Question 39

What is the reason for the computational procedure for consolidated taxable income in the Tax Code?

Answer 39

• The code limites certain transactions (charitable contributions and capital gains/losses). The limits are based on the combined income, not separate.
• Avoid taxing gains and losses between two parts of the consolidated entity (intercompany transactions)
• Intercompany transactions (dividend payments between member companies) should permanently escape taxation - remove from consolidated taxable income

Question 40

Intercompany Transactions

Answer 40

A sale or exchange of goods or services between members of an affiliated group that files a consolidated return. Generally, the results of the transaction are recorded by both affiliates under general Federal income tax rules, but certain gains, losses, income, or deductions may be deferred until a later tax year.

Question 41

Group Items

Answer 41

Net capital gain/loss.
§ 1231 gain/loss.
§ 163(j) interest expense limitation.
Various tax credits and recapture amounts.
Casualty/theft gain/loss.
Charitable contributions.
Dividends received deduction.
Net operating loss.

Question 42

Consolidated NOL is derived after removing any…

Answer 42

consolidated charitable contribution deduction and capital gain or loss from consolidated taxable income

Question 43

Separate Return Limitation Year (SRLY)

Answer 43

A series of rules limits the amount of an acquired corporation’s net operating loss carryforwards that can be used by the acquiror. Generally, a consolidated return can include the acquiree’s net operating loss carryforward only to the extent of the lesser of the subsidiary’s (1) current-year or (2) cumulative positive contribution to consolidated taxable income.