1. C8 - 1 Corporations, Partnerships, Estates & Trusts Chapter 8 Consolidated Tax Returns Copyright ©2009 Cengage Learning Corporations, Partnerships, Estates & Trusts

2. C8 - 2 Corporations, Partnerships, Estates & Trusts 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 Isolate assets of certain ventures from liabilities of other ventures (i.e., obtain limited liability) Carry out estate planning objectives

3. C8 - 3 Corporations, Partnerships, Estates & Trusts 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 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

4. C8 - 4 Corporations, Partnerships, Estates & Trusts 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

5. C8 - 5 Corporations, Partnerships, Estates & Trusts 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 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

6. C8 - 6 Corporations, Partnerships, Estates & Trusts Consolidated Return Advantages (slide 2 of 3) Taxation of intercompany dividends may be eliminated Income on certain intercompany transactions can be deferred Taxation of intercompany dividends may be eliminated Income on certain intercompany transactions can be deferred

7. C8 - 7 Corporations, Partnerships, Estates & Trusts 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 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

8. C8 - 8 Corporations, Partnerships, Estates & Trusts 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 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

9. C8 - 9 Corporations, Partnerships, Estates & Trusts 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 Losses on intercompany transactions are deferred Certain deductions and tax credits may be reduced if limitations are determined based on activities of entire group

10. C8 - 10 Corporations, Partnerships, Estates & Trusts 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 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

11. C8 - 11 Corporations, Partnerships, Estates & Trusts The Consolidated Return Election

12. C8 - 12 Corporations, Partnerships, Estates & Trusts 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 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

13. C8 - 13 Corporations, Partnerships, Estates & Trusts 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 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

14. C8 - 14 Corporations, Partnerships, Estates & Trusts 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 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

15. C8 - 15 Corporations, Partnerships, Estates & Trusts Affiliated Group (slide 3 of 3) Of the 2 corporate group structures illustrated below, both meet the 80% stock ownership test, but the structure on the right is not an affiliated group because there is no identifiable parent entity

16. C8 - 16 Corporations, Partnerships, Estates & Trusts 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 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

17. C8 - 17 Corporations, Partnerships, Estates & Trusts 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 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

18. C8 - 18 Corporations, Partnerships, Estates & Trusts 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 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

19. C8 - 19 Corporations, Partnerships, Estates & Trusts Are these Eligible Groups?

20. C8 - 20 Corporations, Partnerships, Estates & Trusts 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 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

21. C8 - 21 Corporations, Partnerships, Estates & Trusts 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 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

22. C8 - 22 Corporations, Partnerships, Estates & Trusts 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 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

23. C8 - 23 Corporations, Partnerships, Estates & Trusts 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 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

24. C8 - 24 Corporations, Partnerships, Estates & Trusts 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 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

25. C8 - 25 Corporations, Partnerships, Estates & Trusts 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 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

26. C8 - 26 Corporations, Partnerships, Estates & Trusts 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 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

27. C8 - 27 Corporations, Partnerships, Estates & Trusts 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 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

28. C8 - 28 Corporations, Partnerships, Estates & Trusts 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 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

29. C8 - 29 Corporations, Partnerships, Estates & Trusts 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

30. C8 - 30 Corporations, Partnerships, Estates & Trusts 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 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

31. C8 - 31 Corporations, Partnerships, Estates & Trusts 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 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

32. C8 - 32 Corporations, Partnerships, Estates & Trusts 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 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

33. C8 - 33 Corporations, Partnerships, Estates & Trusts 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 This computational procedure allows several transactions to be accounted for on a consolidated basis –e.g., charitable contributions, capital gains and losses

34. C8 - 34 Corporations, Partnerships, Estates & Trusts Computing Consolidated Taxable Income (slide 3 of 3)

35. C8 - 35 Corporations, Partnerships, Estates & Trusts 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 Most intercompany transactions remain in the members’ separate taxable income –Effectively cancel each other out on a consolidated basis

36. C8 - 36 Corporations, Partnerships, Estates & Trusts 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 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

37. C8 - 37 Corporations, Partnerships, Estates & Trusts 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 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

38. C8 - 38 Corporations, Partnerships, Estates & Trusts 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 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

39. C8 - 39 Corporations, Partnerships, Estates & Trusts 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 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

40. C8 - 40 Corporations, Partnerships, Estates & Trusts 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 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

41. C8 - 41 Corporations, Partnerships, Estates & Trusts 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 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

42. C8 - 42 Corporations, Partnerships, Estates & Trusts 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 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

43. C8 - 43 Corporations, Partnerships, Estates & Trusts 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 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

44. C8 - 44 Corporations, Partnerships, Estates & Trusts 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 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

45. C8 - 45 Corporations, Partnerships, Estates & Trusts 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 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

46. C8 - 46 Corporations, Partnerships, Estates & Trusts 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 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

47. C8 - 47 Corporations, Partnerships, Estates & Trusts 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 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

48. C8 - 48 Corporations, Partnerships, Estates & Trusts 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 Certain intercompany transactions receive deferral treatment (cont’d) –Applies to the following transactions among group members: Sale of assets Performance of services

49. C8 - 49 Corporations, Partnerships, Estates & Trusts 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 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

50. C8 - 50 Corporations, Partnerships, Estates & Trusts 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 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