Compliance With Short-Period Return Rules Can Stave Off Penalties and Rejection of Elections as Untimely

By Ryan Wyzik, J.D., LL.M.; Kevin Curran, J.D., LL.M.; and David Friedel, J.D., LL.M., Washington

Editor: Annette B. Smith, CPA

Consolidated Returns

The unextended due date of the return of a domestic corporation, Form 1120, U.S. Corporation Income Tax Return, generally is the 15th day of the third month following the close of the corporation's tax year (Regs. Sec. 1.6072-2(a)). However, when a target corporation joins the consolidated group of a purchasing corporation on a date other than the first day of the target corporation's tax year, the due date for the target corporation's short-period final return is determined without regard to the last day of the short period (Regs. Sec. 1.1502-76(b)(4)).

At the time of this writing, the IRS had just issued proposed regulations under Regs. Sec. 1.1502-76 that would amend paragraph (b)(4) to clarify that the short-period return due date for a target corporation that ceases to exist in the same consolidated-return year in which it becomes a member of a consolidated group is determined without regard to the target's ceasing to exist that year (REG-100400-14). The new regulations are proposed to be prospectively effective; they would apply only to transactions occurring in consolidated-return years that begin after final regulations are published. Even after the IRS finalizes those regulations, however, the uncertainty addressed in this item will continue to exist.

Under the short-period return due-date rules in Regs. Sec. 1.1502-76(c), the due date for the short-period return is determined based on the close of the target corporation's regular tax year as if the year had not ended early due to the acquisition. If the IRS is not informed as part of the target's final short-period return that the return is being filed under this regulatory provision, the IRS may conclude the return was filed late, potentially affecting whether elections required to be made on the return are considered timely. A short-period return that is not timely filed also may trigger failure-to-file and failure-to-pay penalties under Sec. 6651(a), as well as civil penalties if certain international information returns—such as Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Busines s; and 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships—are required to be attached to a timely filed return.

When a target corporation becomes a member of a consolidated group and the target corporation has a short year that ends on the day the consolidated group acquires the corporation, Regs. Sec. 1.1502-76(c) provides the rules for determining the due date of the target's short-period return. That due date is the earlier of the normal due date of the target's return if the target had not been acquired or the due date of the purchasing corporation's consolidated return.

The Internal Revenue Manual

The Internal Revenue Manual (IRM), however, appears to interpret Regs. Sec. 1.1502-76(c) as providing only one due date for the target's short-period return—the due date of the purchasing corporation's consolidated return. IRM Section 3.11.16.6.3.1 provides that the short-period return of the target corporation joining the consolidated group "has the same due date as the consolidated return of the parent [i.e., the purchasing corporation's consolidated return]." The IRM instructs IRS service center personnel that a short-period return can be identified by a statement attached to the return, such as "[c]hanging the tax period to 'get in step with' parent" or "affiliation with a consolidated group." The IRM further instructs IRS personnel not to assess failure-to-file and failure-to-pay penalties against the target for a late-filed return if the target's return is filed by the due date for the purchasing corporation's consolidated return.

The IRM correctly states the rule for a target's short-period return when the due date for the target's final return (including extensions and determined without regard to the acquisition) falls after the due date (including extensions) for the purchasing corporation's consolidated return for the year of the acquisition. The IRM is incorrect, however, in stating that a target corporation's final short-period return is due on the due date (including extensions) of the purchasing corporation's return when the target's Form 1120 otherwise would be due (including extensions) before the Form 1120 filed by the purchasing corporation.

As noted, if the IRS treats a target's final short-period return as filed late, it may treat an election made on the return as untimely. The target could be assessed certain civil penalties, including the $10,000 penalty for each Form 5471, Form 5472, or Form 8865 attached to the return (seeSecs. 6038(b), 6038A(d)(1), and 6046A(e)). Therefore, a target corporation and the purchasing corporation should analyze how to determine the due date of the target's final short-period return under Regs. Sec. 1.1502-76(c) without relying solely on the IRM.

Regs. Sec. 1.1502-76(c)

Regs. Sec. 1.1502-76(c) looks to two dates in determining the due date for a target corporation's short-period return:

  • Regs. Sec. 1.1502-76(c)(1) provides that if the purchasing corporation's consolidated return is due on or before the due date of the target corporation's short-period return based on the target's regular tax year end (including extensions and without regard to the acquisition), then the short-period return must be filed on or before the due date of the purchasing corporation's consolidated return, including extensions.
  • However, Regs. Sec. 1.1502-76(c)(2) provides that if the due date of the target corporation's return (including extensions and without regard to the acquisition) is on or before the due date of the purchasing corporation's consolidated return (including extensions), the short-period return must be filed on or before the due date of the target corporation's return.

Thus, the target corporation's short-period return is due on the earlier of the due date of the target corporation's return based on its regular year end (including extensions and without regard to the acquisition) or the due date of the purchasing corporation's consolidated return (including extensions).

Examples

Assume that P is the parent of a consolidated group and T is a stand-alone corporation.

Example 1: T is a calendar-year taxpayer. P uses a fiscal year ending Sept. 30. P acquires 100% of the stock of T on Nov. 30, 2014. Both P and T file separate Forms 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns. P will file its extension on Dec. 15, 2015, the due date of its return, excluding extensions, for the fiscal year in which the acquisition took place. When should T file its Form 7004, and when is T's final short-period return due?

T's Form 7004 will show that it is being filed for a tax year end of Nov. 30, 2014. The IRS service center that processes the extension will not know until it is informed that T was acquired by P and is filing a final short-period return. To reduce the risk that the Form 7004 might be rejected as untimely, T should file its Form 7004 on or before Feb. 15, 2015, with a statement attached that T has been acquired by P and that the due date of T's final short-period return is determined under Regs. Sec. 1.1502-76(c)(2). The statement should include P's employer identification number (EIN), P's tax year end, and the date on which T will file its final short-period return under this special provision of the consolidated return regulations. T should file its final short-period return on or before Sept. 15, 2015, the due date of T's return (including extensions based on a calendar year end without regard to the acquisition). T should include a copy of the Form 7004 as filed with its return and include a statement that the due date for the return is determined under Regs. Sec. 1.1502-76(c)(2).

Example 2: Assume the same facts as Example 1, except T uses a fiscal year ending Oct. 30, and P acquires 100% of the stock of T on June 30, 2014. When should T file its Form 7004, and when is T's final short-period return due?

T's Form 7004 will show that it is being filed for a tax year end of June 30, 2014. To reduce the risk that the Form 7004 might be rejected as untimely, T should file its extension on or before Sept. 15, 2014, with a statement attached that T has been acquired by P and that the due date for T's final short-period return is determined under Regs. Sec. 1.1502-76(c)(1). The statement should include P's EIN, P's tax year end, and the date on which T will file its final short-period return. T should file its final short-period return on or before June 15, 2015, the due date of P's consolidated return, including extensions for the fiscal year in which the acquisition took place. For additional analysis of the current rules, see Friedel, "Best Practices to Avoid Unpleasant Surprises Under Reg. 1.1502-76(c)," 34 J. Corp. Tax'n (January/February 2007).

Observation

Care must be exercised in identifying the due date for a target corporation's final short-period Form 1120 when the target has been purchased by a U.S. consolidated group. A final short-period return that the IRS treats as not timely filed may result in its treating an election made on the return as not timely. The IRS can also assess civil penalties for certain international information returns that a corporation must attach to a timely filed U.S. income tax return. Taxpayers and practitioners should not read the IRM to the exclusion of Regs. Secs. 1.1502-76(c)(1) and (2) because the IRM's analysis of that regulation is incomplete. The target corporation's Form 7004 extension and the target's final short-period return should be filed with statements that put the IRS on notice that the due date of the target's final return is determined under Regs. Sec. 1.1502-76(c)(1) or (2), whichever is applicable.

EditorNotes

Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.

For additional information about these items, contact Ms. Smith at 202-414-1048 202-414-1048 or annette.smith@us.pwc.com.

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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