Chapter 8
Consolidated Tax Returns
Corporations, Partnerships,
Estates & Trusts
Copyright ©2010 Cengage Learning
Corporations, Partnerships, Estates & Trusts
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Reasons for Using Multiple
Entities (slide 1 of 3)
• Isolate assets of certain ventures from
liabilities of other ventures (i.e., obtain
limited liability)
• Carry out estate planning objectives
Corporations, Partnerships, Estates & Trusts
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Reasons for Using Multiple
Entities (slide 2 of 3)
• Define upper limit on losses in joint venture
with outside party by establishing
minimally funded subsidiary to participate
in venture
• Shield identities of true owners of venture
Corporations, Partnerships, Estates & Trusts
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Reasons for Using Multiple
Entities (slide 3 of 3)
• Enhance market value of entity assets by
taking advantage of goodwill or trade
names of certain members
Corporations, Partnerships, Estates & Trusts
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Consolidated Return Advantages
(slide 1 of 3)
• Current losses can offset income of other
members and reduce current regular tax or
AMT
• Operating and capital loss carryovers of one
member may be used to offset income of
other members
Corporations, Partnerships, Estates & Trusts
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Consolidated Return Advantages
(slide 2 of 3)
• Taxation of intercompany dividends may be
eliminated
• Income on certain intercompany
transactions can be deferred
Corporations, Partnerships, Estates & Trusts
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Consolidated Return Advantages
(slide 3 of 3)
• Certain deductions and tax credits can be
better utilized when subject to limitations of
overall group rather than individual
members
• Basis in stock owned in lower tier entities is
increased as income is reported
Corporations, Partnerships, Estates & Trusts
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Consolidated Return
Disadvantages (slide 1 of 3)
• Election is binding on all members for
current and all subsequent years’ returns
• Election may be terminated if:
– IRS consents to revocation, or
– If membership in group changes and new
member is not included in election
Corporations, Partnerships, Estates & Trusts
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Consolidated Return
Disadvantages (slide 2 of 3)
• Losses on intercompany transactions are
deferred
• Certain deductions and tax credits may be
reduced if limitations are determined based
on activities of entire group
Corporations, Partnerships, Estates & Trusts
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Consolidated Return
Disadvantages (slide 3 of 3)
• Basis in stock owned in lower tier entities is
reduced if losses from the subsidiary are
reported
• Additional reporting requirements exist, and
additional administrative procedures are
necessary
Corporations, Partnerships, Estates & Trusts
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The Consolidated Return
Election
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Electing Consolidated Return
Status
• A corporation can elect to join in a
consolidated return if:
– It is a member of an affiliated group
– It is not ineligible to file on a consolidated basis
– It meets initial and ongoing requirements
Corporations, Partnerships, Estates & Trusts
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Affiliated Group (slide 1 of 3)
• Exists when one corporation owns at least
80% of voting power and stock value of
another corporation
– Ownership test must be met every day of tax
year
– Multiple tiers and chains of corporations are
allowed
– Must have an identifiable parent corporation
• At least 80% of one corporation must be owned by
another
Corporations, Partnerships, Estates & Trusts
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Affiliated Group (slide 2 of 3)
• Affiliated group members can file tax
returns in two ways:
– Each member files a separate return
• Claim a 100% dividends received deduction for
payments passing among them
– Elect to file consolidated tax returns
• No 100% dividends received deduction is allowed
for payments among group members
• Election may not be binding for state purposes
Corporations, Partnerships, Estates & Trusts
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Affiliated Group (slide 3 of 3)
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Affiliated Versus
Controlled Group
• An affiliated group is similar but not identical to a
parent-subsidiary controlled group
• Members of a controlled group are
– Required to share a number of tax benefits, including:
• Discounted marginal tax rates on the first $75,000 of taxable
income
• The $150,000 or $250,000 accumulated earnings credit
• The $40,000 exemption in computing AMT liability
– Must defer recognition of realized loss on intercompany
sales until sale is made at a gain to a nongroup member
– Must recognize as ordinary income gain on the sale of
depreciable property between controlled group
members
Corporations, Partnerships, Estates & Trusts
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Parent-subsidiary
Controlled Group
• Exists when one corporation owns at least
80% of voting power or stock value of
another corporation on the last day of the
year
– Can have multiple tiers of subsidiaries and
chains of ownership
– Must have an identifiable parent
Corporations, Partnerships, Estates & Trusts
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Entities Not Eligible for
Consolidation Election
• Entity type:
– Corporations established outside the US or in a US
possession
– Tax-exempt (charitable) corporations
– Insurance companies
– Partnerships, trusts, estates, limited liability entities, or
other noncorporate entities
• These corporations cannot be used to meet the
stock ownership tests and their incomes cannot be
included in the consolidated return
Corporations, Partnerships, Estates & Trusts
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Are these Eligible Groups?
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Compliance Requirements
(slide 1 of 5)
• Initial consolidated return must meet the
following requirements:
– Form 1120 should include income of all
members of consolidated group
– Form 1122 is filed with first consolidated tax
return
• Represents consent by all entities to be included in
consolidated group
– Election must be made no later than the
extended due date of parent’s return
Corporations, Partnerships, Estates & Trusts
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Compliance Requirements
(slide 2 of 5)
• Subsequent consolidated returns:
– Form 851 is included, which identifies all
group members and shareholdings among the
members
– Form 851 also lists estimated tax payments
made by any member during year
Corporations, Partnerships, Estates & Trusts
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Compliance Requirements
(slide 3 of 5)
• Liability for taxes:
– Each member is jointly and severally liable for
entire consolidated tax liability, penalties and
interest
– Starting with third consolidated tax year,
estimated tax payments must be made on
consolidated basis
Corporations, Partnerships, Estates & Trusts
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Compliance Requirements
(slide 4 of 5)
• Tax liability calculation
– Regular tax is determined using graduated tax rates on
consolidated income
– Lower tax brackets are allocated equally to all members
unless an election is made to allocate such benefits
differently
– Alternative minimum tax liability is based on
consolidated AMTI of group
• Group gets only one $40,000 exemption
• ACE adjustment is computed using consolidated amounts
Corporations, Partnerships, Estates & Trusts
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Compliance Requirements
(slide 5 of 5)
• Accounting periods and methods:
– Tax year of parent must be used by all members
• Short-year return may be required for the first year a
subsidiary is included in the consolidated return
– Accounting methods in place at the date of the
election continue to be used
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 1 of 7)
• Parent corporation’s basis in the
subsidiary’s stock is:
– Initially, the acquisition price
– Adjusted at end of each tax year
• Prevents double taxation of gain or loss on ultimate
disposal of subsidiary’s shares
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 2 of 7)
• Positive adjustments: Basis in subsidiary is
increased by:
– Allocable share of consolidated taxable income
for year
– Allocable share of consolidated operating or
capital loss of subsidiary that could not use the
loss through carryback to a prior year
– Contributions to capital of subsidiary
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 3 of 7)
• Negative adjustments: Basis in subsidiary is
reduced by:
– Allocable share of consolidated taxable loss for year
– Allocable share of operating or capital loss carryover
deducted on consolidated return which did not
previously reduce basis in subsidiary’s stock
– Dividends paid by subsidiary to the parent out of E & P
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 4 of 7)
• When postacquisition taxable losses of
subsidiary exceed acquisition price, an
excess loss account is established
– Allows consolidated return to recognize losses
of subsidiary in current year
– Enables group to avoid reflecting a negative
stock basis in subsidiary
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 5 of 7)
• If stock of subsidiary is redeemed or sold to
third party, any balance in excess loss
account is recognized as capital gain
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 6 of 7)
• In a chain of more than one tier of
subsidiaries, begin computation of stock
basis in lowest-level subsidiary
– Proceed up the ownership structure to parent
Corporations, Partnerships, Estates & Trusts
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Stock Basis of Subsidiary
(slide 7 of 7)
• There is no such concept as consolidated
E&P
– Each entity accounts for its share of
consolidated taxable income
– Immediately recognizes within E & P any
deferred gain or loss on intercompany
transactions
– Reduces E & P by allocable share of
consolidated tax liability
Corporations, Partnerships, Estates & Trusts
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Computing Consolidated
Taxable Income (slide 1 of 3)
• Sequential Approach:
– Compute taxable income separately for each
member of group
– “Group items” and “intercompany items” are
isolated and receive special treatment
– Remaining separate incomes are combined with
group and intercompany items, resulting in
consolidated taxable income
Corporations, Partnerships, Estates & Trusts
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Computing Consolidated
Taxable Income (slide 2 of 3)
• This computational procedure allows
several transactions to be accounted for on a
consolidated basis
– e.g., charitable contributions, capital gains and
losses
Corporations, Partnerships, Estates & Trusts
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Computing Consolidated
Taxable Income (slide 3 of 3)
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Intercompany Transactions
(slide 1 of 4)
• Most intercompany transactions remain in
the members’ separate taxable income
– Effectively cancel each other out on a
consolidated basis
Corporations, Partnerships, Estates & Trusts
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Intercompany Transactions
(slide 2 of 4)
• Most intercompany transactions remain in
the members’ separate taxable income
(cont’d)
– e.g., Services provided by one member to
another member
• Services provider recognizes income
• Service purchaser recognizes deductible expense
• Net result is a zero addition to consolidated taxable
income
Corporations, Partnerships, Estates & Trusts
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Intercompany Transactions
(slide 3 of 4)
• When members involved in the
intercompany transaction use different
accounting methods
– Payor’s deduction for intercompany
expenditure is deferred until year in which
recipient recognizes the related gross income
Corporations, Partnerships, Estates & Trusts
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Intercompany Transactions
(slide 4 of 4)
• Dividends received from other group members
– Eliminated from recipient’s separate taxable income
– No dividends received deduction allowed
– If dividend is noncash asset
• Payor member realizes gain but defers recognition until asset
leaves the group
• The (eliminated) dividend amount = FMV of asset received
Corporations, Partnerships, Estates & Trusts
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Member’s NOLs (slide 1 of 6)
• Usual corporate provisions for NOLs are
available for consolidated losses
– Carryback 2 years
– Then forward 20 years
– Election to forgo carryback for all members is
available
Corporations, Partnerships, Estates & Trusts
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Member’s NOLs (slide 2 of 6)
• In computing consolidated NOL
– Remove consolidated charitable contributions
and capital gain or loss from taxable income
• These items have their own carryover periods and
rules
– The consolidated dividends received deduction
remains a part of the consolidated NOL
Corporations, Partnerships, Estates & Trusts
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Member’s NOLs (slide 3 of 6)
• Complications arise when group members
enter or depart from the consolidated group
– Members’ NOLs are either incurred in a
“separate return year” and deducted in a
“consolidated return year” or vice versa
• Several restrictions limit the availability of such
NOL deductions
Corporations, Partnerships, Estates & Trusts
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Member’s NOLs (slide 4 of 6)
• Where members of consolidated group change
over time, consolidated NOL must be apportioned
to group members using the following formula:
Member’s separate NOL × Consolidated NOL
Members’ aggregate NOL
= Member’s apportioned NOL
Corporations, Partnerships, Estates & Trusts
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Member’s NOLs (slide 5 of 6)
• In years when group member files a separate
return, only the apportioned NOL may be carried
over
• When member leaves the group, any apportioned
share of unused loss carryforwards can be used on
its subsequent separate returns
Corporations, Partnerships, Estates & Trusts
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Member’s NOLs (slide 6 of 6)
• Separate return limitation year (SRLY) rules
apply when NOLs are carried forward from
a separate return year onto a consolidated
return
• Consolidated return can include loss from
member’s SRLY period only to lesser of its:
• Current year income, or
• Cumulative positive contribution to current year
consolidated income
Corporations, Partnerships, Estates & Trusts
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Computation of Group Items
(slide 1 of 2)
• Several items are computed on a consolidated
basis including:
–
–
–
–
–
–
–
–
Net capital gain/loss
§ 1231 gain/loss
§ 199 domestic production activities deduction
Casualty/theft gain/loss
Charitable contributions
Dividends received deduction
Net operating loss
AMT adjustments and preferences
Corporations, Partnerships, Estates & Trusts
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Computation of Group Items
(slide 2 of 2)
• Several items are computed on a
consolidated basis (cont’d)
– All of these items are removed from members’
separate taxable income
• Then use consolidated taxable income to that point
to determine statutory limitations for group-basis
gains, losses, income, and deductions
Corporations, Partnerships, Estates & Trusts
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The Matching Rule (slide 1 of 3)
• Certain intercompany transactions receive
deferral treatment
– Gain or loss realized is removed from taxable
income until the sold asset leaves the group
– Prevents accelerating loss deductions on sales
of assets within the group
Corporations, Partnerships, Estates & Trusts
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The Matching Rule (slide 2 of 3)
• Certain intercompany transactions receive
deferral treatment (cont’d)
– Applies to the following transactions among
group members:
• Sale of assets
• Performance of services
Corporations, Partnerships, Estates & Trusts
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The Matching Rule (slide 3 of 3)
• The entire deferred gain or loss is included
in consolidated taxable income when:
– The asset is transferred outside the group
– The transferor of property leaves the group
– Consolidation election is terminated
Corporations, Partnerships, Estates & Trusts
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If you have any comments or suggestions concerning this
PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta
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