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Consolidated Returns — Investment Subsidiaries (Portfolio 755)

Tax Management Portfolio, Consolidated Returns — Investment in Subsidiaries, No. 755-3rd, analyzes the concepts involved in the ownership of subsidiary stock within an affiliated group filing consolidated returns. Because consolidated returns result in the computation of a single tax liability for separate entities, application of the separate tax rules would lead to unjustified tax results. For example, a subsidiary's income or losses could be reflected a second time as gain or loss on disposition of the subsidiary's stock. Also, shifts of equity (dividends, nondividend distributions, liquidations, and redemptions) within the group would lead to substantially different tax results from economically similar transactions within a single corporation with several divisions. Similarly, intercompany transactions could lead to discontinuities in the earnings and profits of group members.

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Tax Management Portfolio, Consolidated Returns — Investment in Subsidiaries, No. 755-3rd, analyzes the concepts involved in the ownership of subsidiary stock within an affiliated group filing consolidated returns. Because consolidated returns result in the computation of a single tax liability for separate entities, application of the separate tax rules would lead to unjustified tax results. For example, a subsidiary's income or losses could be reflected a second time as gain or loss on disposition of the subsidiary's stock. Also, shifts of equity (dividends, nondividend distributions, liquidations, and redemptions) within the group would lead to substantially different tax results from economically similar transactions within a single corporation with several divisions. Similarly, intercompany transactions could lead to discontinuities in the earnings and profits of group members.
This Portfolio describes and analyzes: (1) the adjustments made to the basis of subsidiary stock to reflect the subsidiary's income or losses; (2) the provisions in the regulations which minimize the tax consequences of intercompany dividends and nondividend distributions; (3) the special treatment of intercompany liquidations and redemptions; (4) the restoration to income of “excess losses,” which are amounts previously deducted as losses of a subsidiary and which exceed the group's economic investment in the subsidiary; (5) computation of earnings and profits within an affiliated group; and (6) allocation of a group's tax liability among its members.
For a discussion of eligibility to file consolidated returns and the scope of the consolidated return regulations, see 754 T.M., Consolidated Returns — Elections and Filing. For an analysis of: (1) the computation of separate taxable income; (2) the computation of consolidated income items, such as capital gain or loss and §1231 gain or loss; and (3) the computation of consolidated tax credits, see 756 T.M., Computation of Consolidated Tax Liability. For an analysis of the limitations imposed by the consolidated return regulations on the use of losses, such as the separate return limitation year rules and §382, see 757 T.M., Consolidated Return Regulations – Limitations on Losses.


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AUTHORS

GEORGE L. WHITE
George L. White, B.A., Holy Cross College (1958); M.B.A., University of Pennsylvania (1960); LL.B., Harvard University (1963); admitted to practice in Massachusetts; Certified Public Accountant, Massachusetts.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Basis Adjustments

Introductory Material

A. Separate Return Tax Treatment

1. General Rules

2. Exception

B. Consolidated Return Basis Adjustments

1. Background

2. Statement of Purpose

3. Overview

a. Generally

b. Excess Loss Account

c. Tiering-up

4. Stock Basis Adjustments

a. Timing

b. Amount

c. Operating Rules

(1) Taxable Income or Loss

(2) Tax-Exempt Income

(a) Generally

(b) Equivalent Deductions

(c) Cancellation of Debt (COD) Income

(d) Basis Shifts

(3) Noncapital, Nondeductible Expenses

(a) Generally

(b) Expired Loss Carryovers

(c) Waiver of SRLY Loss Carryovers

(d) Tax Sharing Agreements

5. Distributions

6. Allocation of Stock Basis Adjustments

a. Introduction

b. Generally

c. Minority Stock

d. Preferred Stock

e. Common Stock

(1) Allocation Within a Class of Common Stock

(2) Allocation Among Different Classes of Common Stock

f. Varying Interests

g. Preferred Stock Treated as Common Stock

h. Cumulative Redetermination

i. Anti-avoidance Rule

(1) Generally

(2) Examples

7. Annual Reporting Requirement

8. Changes in Structure of Group

a. Introduction

b. General

c. Transactions to Which Regs. § 1.1502-31 Applies

(1) In General

(2) Asset Acquisition

(3) Stock Acquisition

(4) Net Asset Basis

9. Effective Date

a. General Rule

b. Dispositions of Stock Before Effective Date

(1) General Rule

(2) Exception for Lower-tier Member

(3) Disposition Defined

c. Distributions

(1) Deemed Dividend Election

(2) Affiliated E& P

d. Expiring Loss Carryovers

e. Basis Reduction Accounts

10. Permission to Deconsolidate

C. Basis Adjustment on Subsidiary Stock after Disposition or Deconsolidation

III. Excess Losses

A. Background

B. Overview

C. Disposition Defined

1. Generally

2. Exception

D. Worthlessness

1. General Rule

2. Special Rules

E. Character of Income

1. General Rule: Gain from Sale of Stock

2. Exception for Insolvency of Subsidiary

a. Ordinary Income

b. Reduction of Ordinary Income Treatment

F. Basis of ELA Stock

1. Equalization of Basis

2. Rule Reducing Basis of Other Investment: Election Eliminated

G. Examples

H. Anti-Avoidance

I. Effective Date

1. Generally

2. Dispositions of Stock Before Effective Date

a. Generally

b. Disposition Defined

J. Circular Basis Adjustments; Regs. § 1.1502-11(b)

1. Background

2. Purpose

3. General Rule

4. Multiple Dispositions of Subsidiaries

a. Chain of Subsidiaries

b. Brother-Sister Subsidiaries

c. Loss Dispositions

5. Effective Date

IV. Intercompany § 301 Distributions

A. Introduction

B. Separate Return Tax Treatment

1. Dividends

2. Nondividend Distributions

3. Property Distributions

C. Consolidated Return Tax Treatment - § 301 Distributions

1. Overview

a. Definitions

(1) Intercompany Transaction

(2) Nomenclature

(3) Intercompany Items

(4) Corresponding Items

b. Rules of Operation

(1) Matching Rule

(2) Acceleration Rule

2. Exclusion from Gross Income

3. Timing

4. Treatment of Distributing Corporation

5. Boot in Intercompany Reorganizations

6. Issuer's Acquisition of Its Own Stock

7. Certain Liquidations and Distributions

a. Problem

b. Relief

(1) Actual Liquidations Under § 332

(2) Downstream Mergers

(3) Deemed Liquidations Under § 338(h)(10)

(4) Deemed Liquidations in Forward Cash Merger

(5) Spin-off

c. Elections

d. 2008 Temporary (and Proposed) Regulation

8. Common Parent Stock

a. Background

b. Overview

c. Common Parent Stock (P Stock)

d. Loss Stock

e. Waiver of Built-in Loss on P Stock

f. Gain Stock

g. Dealers in P Stock

h. Positions in P Stock

i. Effective Dates

9. Anti-Avoidance

10. Effective Date

a. Generally

b. Exception

c. Early Election

d. Permission to Deconsolidate

V. Intercompany Liquidations and Redemptions

A. Separate Return Tax Treatment

1. Section 332 Liquidations

2. Section 331 Liquidations

3. Section 302 Redemptions

B. Consolidated Return Tax Treatment

1. Section 332 Liquidations

2. Section 302 Redemptions

3. Mirror Transactions

a. Background

b. Classic Mirror Transaction

c. 80% Distributee

d. No 80% Distributee

4. Effective Date

VI. Intercompany Obligations

A. Introduction

B. Separate Return Tax Treatment

1. General Rule

2. Bad Debts

3. Acquisition of Debt by Affiliate of Debtor

C. Consolidated Return Tax Treatment

1. Overview

2. Definitions

a. Obligation of Member

b. Intercompany Obligations

c. Intercompany Transaction

d. Nomenclature

e. Intercompany Items

f. Corresponding Items

3. General Rules of Operation

a. Matching Rule

b. Acceleration Rule

4. Special Rules

a. Intercompany Obligation Becomes Nonintercompany Obligation

(1) In General

(2) Exceptions

b. Nonintercompany Obligation Becomes Intercompany Obligation

5. Exception

6. Proposed Regulations

a. Issues

b. 1998 Proposed Regulations

c. 2007 Proposed Regulations

(1) Simplified Mechanics of Deemed Satisfaction and Reissuance Model: Intragroup and Outbound Transactions

(2) Limitations on Application of Model to Intragroup Transactions

(3) Intragroup Off-Market Issuance Rule

(4) Outbound Transactions: Special Rules

(5) Inbound Transactions

(6) Effective Date

7. 2008 Final Regulations

8. Anti-Avoidance

9. Effective Date

VII. Earnings and Profits

A. Overview

B. General

C. Tiering Up of Adjustments

1. Unabsorbed Losses

2. Tax Sharing Rules

3. Distribution of Certain Affiliated E& P

D. Special Rules

1. Stock of Members

2. Intercompany Transactions

E. Dividend Stripping

1. Overview

2. Deconsolidations

a. General

b. Exception for Acquisition of Group

c. Exception for Corporate Separations and Reorganizations

d. Exception for Special Use E& P

F. Changes in Structure of Group

1. General

2. New Common Parent

3. Changes in Position of Subsidiaries

G. Effective Dates

1. Generally

2. Dispositions of Stock Before Effective Date

a. Generally

b. Exception for Lower-tier Member

c. Disposition Defined

3. Deconsolidations

4. Deemed Dividend Elections

VIII. Allocation of Consolidated Tax Liability

A. Overview

B. Allocation under § 1552

1. Methods of Allocating Tax Liability

a. Contribution to Consolidated Taxable Income

b. Separate Return Tax Liability

c. Separate Allocation of Tax Increases Arising from Consolidation

d. Other Methods

2. Application of Rules

a. Tax Liability of Group

b. Effect of Allocation

3. Method of Election

C. Allocation under Regs. § 1.1502-33(d)

1. Background

2. Overview

a. Wait-and-See Method

b. Percentage Method

c. Additional Methods

d. Effect of Allocation

e. Method of Election

(1) Generally

(2) Prior Law Elections

(a) Continuity

(b) Conformity


WORKING PAPERS

Working Papers

Table of Worksheets

Other Sources

Worksheet 1 Conference Report to Accompany H.R. 3545 the Omnibus Budget Reconciliation Act of 1987 (P.L. 100-203) H.R. Rep. No. 495 (Conf.), 100th Cong., 1st Sess. 960-963 (1987) (Excerpt)

Worksheet 2 Letter from Treasury Secretary Baker re Mirror Subsidiary Transactions (Dec. 9, 1986)

Worksheet 3 Preamble to CO-30-92, 57 Fed. Reg. 53634 (11/11/92) (Proposed Investment Adjustment Regulations)

Worksheet 4 Preamble to T.D. 8560, 59 Fed. Reg. 41666 (8/15/94) (Final Investment Adjustment Regulations)

Worksheet 5 Notice of Hearing for CO-11-91, 59 Fed. Reg. 18048 (4/15/94) (Proposed Intercompany Transaction Regulations)

Worksheet 6 Preamble to T.D. 8597, 60 Fed. Reg. 36671 (7/18/95) (Final Intercompany Transaction Regulations)

Worksheet 7 Preamble to T.D. 8598, 1995-2 C.B. 188 (Intercompany Transactions)

Worksheet 8 Preamble to T.D. 8660, 61 Fed. Reg. 10447 (3/14/96) (Intercompany Transactions)

Worksheet 9 Preamble to T.D. 8677, 61 Fed. Reg. 33321 (6/27/96) (Final and Temporary Regs. Limitations on the Use of Certain Losses and Deductions)

Worksheet 10 Preamble to REG-105964-98, 63 Fed. Reg. 70354 (12/21/98) (Prop. Regs., Intercompany Obligations)

Worksheet 11 Preamble to T.D. 8823, 64 Fed. Reg. 36091 (7/2/99) (Final and Temp. Regs., Limitations on the Use of Certain Losses and Deductions)

Worksheet 12 Preamble to T.D. 8824, 64 Fed. Reg. 36116 (7/2/99) (Final and Temp. Regs., Limitations on Net Operating Loss Carryforwards and Certain Built-in Losses and Credits Following an Ownership Change of a Consolidated Group)

Worksheet 13 Preamble to T.D. 8884, 65 Fed. Reg. 33753 (5/25/00) (Final Regs., Limitations on the Use of Certain Credits)

Worksheet 14 Election to Use Tax Allocation Method Under § 1552 Other Than Method Prescribed by § 1552(a)(4)

Worksheet 15 Application for Consent to Use Special Allocation Method Under § 1552(a)(4) for First Consolidated Return

Worksheet 16 Application for Consent to Change to Special Allocation Method Under § 1552(a)(4)

Worksheet 17 Election to Use Tax Allocation Method Under Regs. § 1.1502-33(d)(2) or (3)

Bibliography

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Internal Revenue Code:

Treasury Regulations:

Treasury Rulings:

Cases:

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