Chapter 8 - Consolidated Tax Return Flashcards
What are nontax considerations for combining corporations?
- 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
Consolidated Returns
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.
What are the two goals for consolidated return rules (Congress and Treasury Department)?
- Treat certain corporate groups as a single entity to the extent possible
- Limit/eliminate incentives to purchase another corporation to acquire its tax attributes like NOLs, capital losses, and tax credits
The consolidated return rules may be available to a taxpayer as a result of various business decisions:
- 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.
What are tax advantages for group members filing consolidated returns?
- Elimination of all intercompany dividends from consolidated taxable income.
- Use of shares held by all group members to meet certain other statutory requirements.
- The ability of group members to offset income with losses from other members. This applies to operating, capital, and other losses.
What are tax disadvantages for group members filing consolidated returns?
- 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.
- The requirement that all group members use the parent’s tax year may create short tax periods for subsidiaries when they join the group.
- Consolidated groups incur additional administrative costs in computing consolidated tax liabilities and in complying with the consolidated return Regulations generally.
What are tax considerations that could be advantageous or disadvantageous, depending on the situation?
- Certain consolidated deductions and credits can be either higher or lower due to using consolidated limitations instead of the separate company limits.
- 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.
- 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.
A corporation can join in a consolidated tax return if it meets three requirements:
- It is a member of an affiliated group.
- It is not ineligible to file on a consolidated basis.
- It meets the initial and ongoing compliance requirements specified in the Code and Regulations.
Affiliated Group
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).
Members of an affiliated group can file tax returns in either of two ways:
- File a separate tax return for each member of the group, and claim a 100% dividends received deduction for payments passing among them.Footnote
- 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.
Controlled Group
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.
Members of a controlled group must defer the recognition of any realized loss on intercompany sales until…
A sale is made at a gain to a nongroup member
Any gain on the sale of depreciable property between members of a controlled group is recognized as…
ordinary income
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?
- Corporations established outside the United States or in a U.S. possession.
- Tax-exempt corporations.
- Insurance companies.
- Partnerships, trusts, estates, limited liability entities, and other noncorporate entities.
What requirements must the first consolidated tax return of an affiliated group meet?
- 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.
- Form 1122 should be attatched to the first consolidated tax return for each of the subsidiaries included in the group.
- The consolidation election must be made no later than the extended due date of the partent’s return for the year.
An application to terminate the consolidation election must be filed at least __ days prior to the extended due date of the consolidated return.
90
Generally, when a subsidiary leaves an ongoing consolidated group, it must wait __ years before it can reenter the same parent’s consolidated group.
5
851 Affiliations Schedule
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.
When are consolidated tax returns due?
15th day of the 4th month following the close of the group’s tax year (usually April 15th for calendar year taxpayer)
Form 7004
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
How are group members liabile for the entire consolidated income tax liability?
jointly and severally liable
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.
3rd.
Separate or Consolidated
Treasury Regulations sanction two methods for sharing consolidated tax liabilities:
the relative taxable income and relative tax liability methods.
Relative Taxable Income Method
The consolidated tax liability is allocated among the members based on their relative amounts of separate taxable income.
Relative Tax Liability Method
The consolidated tax liability is allocated based on the relative hypothetical separate tax liabilities of the members.
Do all members of a consolidating group have to use the parent’s tax year?
Yes
What tax accounting methods are used by the members of a consolidated group?
The method that was in place prior to the consolidation election (members of a consolidated group may use different accounting methods)
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.
Gross Receipts
Cash to Accrual
An acquiring parent corporation records a subsidiary stock basis on its tax balance sheet equal to…
the cost of the stock
Unlike most taxpayers, the acquiring parent corporation must…
adjust its basis in the subsidiary stock in a procedure that is similar to the equity method of financial accounting
Why does the parent have to adjust its stock basis?
To prevent double taxation of gain if the parent later sells the subsidiary’s shares
Positive adjustments to the subsidiary stock basis for the parent
- An allocable share of consolidated taxable income for the year.
- 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.
Negative adjustments to the subsidiary stock basis for the parent
- An allocable share of a consolidated taxable loss for the year.
- An allocable share of any carryover operating or capital losses that are deducted on the consolidated return and have not previously reduced stock basis.
- Dividends paid by the subsidiary to the parent (i.e., distributions from the subsidiary’s E & P).
When accumulated postacquisition negative adjustments to the stock basis of the subsidiary exceed the acquisition price plus prior positive adjustments, the stock basis becomes…
zero and an excess loss account is created
Excess loss account
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.
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…
the excess loss account
There is no such concept as consolidated E&P, rather…
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
What are the steps to calculating consolidated taxable income?
- Compute each group member’s taxable income separately.
- 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.
- 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.
What is the reason for the computational procedure for consolidated taxable income in the Tax Code?
- 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
Intercompany Transactions
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.
Group Items
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.
Consolidated NOL is derived after removing any…
consolidated charitable contribution deduction and capital gain or loss from consolidated taxable income
Separate Return Limitation Year (SRLY)
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.
