8-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-2 CONSOLIDATIONS (1 of 2)  Affiliated groups  Consolidated tax return election  Consolidated taxable income  Intercompany transactions  Items computed on a consolidated basis  Net operating losses (NOLs) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-3 CONSOLIDATIONS (2 of 2)  Stock basis adjustments  Tax planning considerations  Compliance and procedural considerations  Financial statement implications ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-4 Affiliated Groups Stock Ownership Requirement  Parent must directly own 80% of voting power & 80% of total value of stock of at least one subsidiary  Parent & other group members must own 80% of the voting power & 80% of value of each corporation to be included in the group ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-5 Affiliated Groups Excluded Corporations  Tax exempts under §501  Insurance companies under §801  Foreign corporations  May elect to treat 100% owned Canadian or Mexican corp as domestic  Regulated investment companies  Real estate investment trusts  S corporations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-6 Affiliated Groups Comparison with Controlled Group Definitions (1 of 2)  Brother-sister controlled groups cannot file consolidated returns  Parent-subsidiary controlled groups and parent-subsidiary portion of combined controlled groups can file consolidated returns ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-7 Affiliated Groups Comparison with Controlled Group Definitions (2 of 2)  Differences between rules  Stock ownership for affiliated group is ≥80% of voting power AND value  Attribution rules more strict for affiliated groups  Excluded corporations differ  Affiliated group definition tests done on each day of the year, not just 12/31 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-8 Consolidated Tax Return Election (1 of 2)  §§  Very general  Primarily define affiliated groups eligible to file consolidated return  Statutory and interpretative Regs used to determine consolidated tax liability and filing requirements ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-9 Consolidated Tax Return Election (2 of 2)  Termination of consolidated filing  Termination of affiliated group  Good cause request to discontinue  Effects of former members  Gains and losses deferred on intercompany transactions may have to be recognized under acceleration rule  Consolidated return attributes must be allocated among former group members ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-10 Consolidated Taxable Income Accounting Periods and Methods  Accounting periods  Consolidated return must conform to parent’s tax year  Accounting methods  Each group member’s method used for separate filing is used for consolidated return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-11 Consolidated Taxable Income Calculation (1 of 2) 1. Compute each member’s income 2. Adjust each member’s income  Adjustments made to take into account special consolidated treatment 3. Remove any item that is reported on a consolidated basis  Resulting amount is separate taxable income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-12 Consolidated Taxable Income Calculation (2 of 2) 4. Combine separate taxable income (STI) of each member  Resulting amount is combined TI 5. Adjust combined taxable income for items reported on a consolidated basis  Resulting amount is consolidated taxable income (or NOL) See Table 1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-13 Intercompany Transactions (1 of 3)  Transactions between corporations that are members of the same affiliated group immediately after the transaction  Matching rule  Consolidated group treats intercompany item as if both companies were divisions of a single company ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-14 Intercompany Transactions (2 of 3)  Acceleration rule  When a member leaves the group, any transaction involving the departing member is fully taken into account ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-15 Intercompany Transactions (3 of 3)  Examples include:  Property transactions  Performance of services  Licensing of technology  Renting of property  Lending of money  Subsidiary’s distribution to parent  Dividend or redemption ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-16 Property Transactions (1 of 2)  Group members recognize gain or loss on intercompany property transfers in computing separate taxable income  Intercompany gain or loss excluded from consolidated income until a later event triggers recognition ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-17 Property Transactions (2 of 2)  Examples of recognition events:  Buyer claims depreciation, amortization or depletion on purchased asset  Amortization of capitalized services  Departure from the group by either buyer or seller  Parent starts a separate return year ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-18 Other Intercompany Transactions  Both parties report their side of the transaction in determining separate taxable income  Net effect upon consolidation is zero  If parties use different methods or tax years, adjustments to match income and expense are required ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-19 Items Computed on a Consolidated Basis (1 of 2)  Charitable contribution deduction  Net §1231 gain or loss  Capital gains and losses  Dividends received deduction  U.S. production activities deduction ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-20 Items Computed on a Consolidated Basis (2 of 2)  Regular tax liability  AMT liability  Tax credits  Estimated tax payments ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-21 Charitable Contribution Deduction  The affiliated group’s charitable contribution deduction is computed on a consolidated basis  Sum the individual contributions  10% limitation based on adjusted consolidated taxable income  Same as adjusted taxable income for a corporation  Carryover the excess for 5 years ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-22 Capital Gains and Losses  Determined in manner similar as for single corporation  Departing members’ capital losses  Rules similar to NOL treatment  Departing member allocated a portion of capital loss carryover  SRLY limitation for carrybacks from separate return year ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-23 Dividends Received Deduction  Dividends received from other group members are excluded from consolidated income  Dividends-received deduction applied on a consolidated basis for dividends from non-group member corporations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-24 U.S. Production Activities Deduction (1 of 3)  The affiliated group’s U.S. production activities deduction (CPAD) is computed on a consolidated basis  Lesser of  Consolidated productive activities income OR  Consolidated taxable income before CPAD deduction ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-25 U.S. Production Activities Deduction (2 of 3)  For purposes of computing CPAD, definition of affiliated group stock ownership threshold is 50% instead of 80%  Lower threshold may require inclusion of corps in this deduction that are not part of the consolidated return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-26 U.S. Production Activities Deduction (3 of 3)  Production activities income computed on consolidated basis and then deduction allocated to corps based on relative amount of qualified production activities income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-27 Regular Tax Liability  Multiply consolidated taxable income by the appropriate tax rate(s) in §11  If affiliated group chooses files separate tax returns, reduced tax rates on lower income apply only one time regardless of number of members in group ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-28 Corporate AMT Liability  AMT prepared on a consolidated basis for all group members  Computation parallels determination of group’s consolidated taxable income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-29 Tax Credits  Affiliated groups may claim all tax credits available to corporations  Determined on a consolidated basis ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-30 Estimated Payments  1 st two years option to make on separate or consolidated basis  After 2 nd year must be on consolidated basis ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-31 Consolidated NOLs  Current year NOLs  Carryovers of consolidated NOLs  Carryback to separate return year  Carryforward to separate return year  Special loss limitations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-32 Current Year NOLs (1 of 2)  All members’ income/losses combined  Loss from one member offsets income from another member ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-33 Current Year NOLs (1 of 2)  Carrybacks and carryforwards done on consolidated basis if group has not changed its members  Carryback 2 yrs and forward 20 years  Taxpayer can elect to carryback NOL from 2008 or , 4, or 5 years ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-34 NOL Carrybacks and Carryovers NOL Allocated to Members with Separate Loss ©2011 Pearson Education, Inc. Publishing as Prentice Hall Separate NOL of member ___________ Sum of all separate NOLs Consolidated NOL X = Portion of consolidated NOL attributable to member

8-35 NOL Carrybacks and Carryovers NOL Carryforwards  If corporation leaves the affiliated group, the departing corp takes its share of consolidated NOL with it ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-36 Special Loss Limitations SRLY (1 of 3)  Parent-sub relationship exists  Subsidiary has been filing separate returns and has NOLs  Upon joining group, the sub’s losses can be used to offset future consolidated income subject to SRLY limitations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-37 Special Loss Limitations SRLY (2 of 3)  NOL allocable to departing member becomes member’s separate CF only after all available carryovers are absorbed in current consolidated return year  NOL CF incurred in SRLY lesser of  Loss member’s income, gain, deduction, and loss minus NOLs previously absorbed for all consolidated return years of group,  Consolidated taxable income, or  Amount of the NOL carryover ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-38 Special Loss Limitations SRLY (3 of 3)  SRLY carryover cannot be used when member’s cumulative contribution < $0  SRLY rules also apply to carrybacks for corporations who leave group and later carryback NOLs to consolidated years  In a reverse acquisition, SRLY limitation applies the acquiring corp’s NOLs ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-39 Special Loss Limitations §382 (1 of 2)  §382 limitation applied when unrelated corp (or group) added as a subsidiary and has NOLs  Limitation determines dollar amount of loss carryforward from new sub (or sub group) that can be applied to reduce consolidated taxable income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-40 Special Loss Limitations §382 (2 of 2)  Loss limitation  Value of loss group x federal interest rate  Loss group value is value of all common & pref stock owned by outsiders immediately before change of ownership  SRLY NOL creates deferred tax asset  May be subject to a valuation allowance ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-41 Stock Basis Adjustments (1 of 2)  Annually, basis for investment in a subsidiary corporation is adjusted  Adjustment parallels the “equity” method of accounting for investments but uses tax numbers instead of book income numbers  Adjustments listed on page 35 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-42 Stock Basis Adjustments (2 of 2)  Large negative basis adjustments can reduce a sub’s stock basis to $0  Negative basis adjustments when sub’s basis is $0 creates an excess loss account  Subsequent positive adjustments reduce (or eliminate) the excess loss account ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-43 Tax Planning Considerations Advantages of Consolidating (1 of 2)  Losses in one member offset gains in another in the current year  Intragroup dividends are eliminated  Combined credits and deductions may avoid carryovers  Intragroup gains are deferred  Consolidated AMT may reduce the negative effects of AMT adjustments ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-44 Tax Planning Considerations Advantages of Consolidating (2 of 2)  Parent corp (& upper tier corps) increase its bases in subsidiary stock investments for sub’s taxable income, eliminating double taxation ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-45 Tax Planning Considerations Disadvantages of Consolidating  Election binding on subsequent years  Members must use same tax year  Intragroup losses are deferred  Intragroup losses may reduces the limitation on certain deductions and credits  Additional administrative cost ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-46 Compliance and Procedural Considerations (1 of 2)  Basic election and return  File Form 1120  Including Form 851 affiliations schedule  Subs’ consent to election use Form 1122  Must provide a columnar schedule reconciling consolidated income with members’ separate incomes ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-47 Compliance and Procedural Considerations (1 of 2)  Parent corp acts as agent for group  Parent can request IRS consent to treat intercompany transactions on a separate entity basis  Tax treatment of affiliated groups for state income tax purposes of varies from state to state ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-48 Financial Statement Implications Intercompany Transactions (1 of 2)  Discussion based on 100%-owned sub  Intercompany dividends  Eliminated for both tax and book whether filing separately or consolidated  Intercompany sales  Defers intercompany income for book and tax if filing consolidated return  Deferred amounts may differ ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-49 Financial Statement Implications Intercompany Transactions (2 of 2)  Intercompany sales (continued)  If filing separate returns  Seller recognizes income for tax purposes, but not for financial stmt purposes  Group recognizes deferred tax asset on difference between profit deferred in consolidated financial stmts and taxes paid on seller’s separate tax return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8-50 Financial Statement Implications SRLY Losses  NOL from SRLY creates deferred tax asset  Possibly subject to a valuation allowance ©2011 Pearson Education, Inc. Publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 8-51 ©2011 Pearson Education, Inc. Publishing as Prentice Hall