Proposed Regulations Would Provide Guidance for Allocation and Absorption of Losses on a Consolidated Return

Editor: Mark G. Cook, CPA, MBA, CGMA

Under rules for consolidated returns, the consolidated net operating loss (NOL) or consolidated taxable income is the sum of each entity’s separate taxable income or loss calculated under Regs. Sec. 1.1502-12 and certain items of income and deduction computed on a consolidated basis under Regs. Sec. 1.1502-11. Proposed regulations issued in June (Prop. Regs. Sec. 1.1502-21, REG-101652-10) address an issue when there is a consolidated NOL.

Under current consolidated NOL rules, Regs. Sec. 1.1502-21(b)(2)(i) states that when a group has a consolidated NOL and that NOL is attributable to a member and can be carried to a separate return year, the amount of the consolidated NOL that is attributable to the member is apportioned and carried to the separate return year. The apportioned amount of the consolidated NOL attributable to a member is determined under Regs. Sec. 1.1502-21(b)(2)(iv).

The apportioned amount is calculated by multiplying the consolidated NOL by the separate NOL of the member for the consolidated return year divided by the sum of the separate NOLs of all members having such losses. The separate NOL of a member is determined by computing the consolidated NOL by reference to only that member’s items of income, gain, deduction, and loss. However, the current regulations do not expressly adopt this same fraction-based method for computing the amount of each member’s absorbed loss that is used to offset the income of members with positive separate taxable income or net capital gain for the consolidated return year in which the loss is recognized.

The apportionment method in Regs. Sec. 1.1502-21(b)(2)(iv) generally produces appropriate results; however, an issue may develop when one or more of the entities has a capital gain.

Example 1. Current law without capital gains: Company A, the parent, acquires Company B, the subsidiary. Company A and Company B file a consolidated return for the tax year ending after the acquisition. For the consolidated year, Company A generates a $100 loss, and Company B generates a $200 loss. Thus, the consolidated group has a $300 consolidated loss.

The amount of the consolidated NOL attributable to each member is determined taking into account only its items; therefore, Company A is allocated a $100 loss (the consolidated NOL of $300 × [the separate NOL of $100 ÷ $300]). Company B is allocated a $200 loss (the consolidated NOL of $300 × [the separate NOL of $200 ÷ $300]).

Example 2. Current law with capital gains: Company A, the parent, acquires Company B, the subsidiary. Company A and Company B file a consolidated return for the tax year ending after the acquisition. For the consolidated year, Company A generates $100 of capital gain and $100 of deductible expenses, and Company B generates a $100 capital loss. The consolidated group has a $100 consolidated loss.

In this situation, Company A’s portion of the $100 consolidated NOL is zero because A has no separate NOL: Its $100 of capital gains are offset by its $100 of expenses. Company B’s portion of the consolidated NOL is also zero because, while it has a net capital loss, it has no separate NOL. Thus, as this example demonstrates, it is unclear how to calculate the allocation of a consolidated NOL when a member or members of a consolidated group have a capital gain or loss.

To solve this problem, the proposed regulations adjust the calculation described under Regs. Sec. 1.1502-21(b)(2)(iv). The proposed regulations provide that, solely for apportionment purposes, the separate NOL of a member is its loss determined without regard to capital gains (or losses) or amounts treated as capital gains.

Example 3. Proposed law with capital gains calculation exclusion: The facts are the same as in Example 2. Under the proposed regulations, Company A’scapital gains are ignored so it has a separate NOL of $100. Company B’s capital loss is also ignored, so it has no separate NOL. Because A’s separate NOL is 100% of the combined separate NOLs of Company A and Company B, Company A would be allocated all $100 of consolidated NOL.

In addition to this change in the apportionment calculation, the proposed regulations clarify that the absorption of members’ losses to offset income of other members in the consolidated return year is made on a pro rata basis, consistent with the pro rata absorption of losses from tax years ending on the same date that are carried back or forward under the rules of Regs. Secs. 1.1502-21(b) and 1.1502-22(b) (relating to net capital loss carrybacks and carryovers).

The amendments to Regs. Sec. 1.1502-21(b)(2)(iv) would apply to consolidated return years beginning on or after the date these regulations are published as final in the Federal Register.

EditorNotes

Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.

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