Proposed regulations would update rules for consolidated returns

Editor: Susan Minasian Grais, CPA, J.D., LL.M.

Proposed regulations (REG-134420-10) for corporations that file U.S. federal consolidated income tax returns would update guidance under Sec. 1502 for statutory changes made over the last 50 years, modernize and clarify language, and facilitate taxpayer compliance. The proposed regulations would also partially or completely withdraw certain notices of proposed rule-making and temporary regulations that are no longer necessary.

Proposed changes

Most of the proposed changes aim at cleaning up current regulations to remove references to inapplicable provisions, incorporate current provisions, and modernize the language.

To account for recent statutory changes, the proposed regulations would modify the definition of the term “tax” in Regs. Sec. 1.1502-5 for purposes of computing estimated taxes to add a reference to the corporate alternative minimum tax under Sec. 55(a) and the base erosion and anti-abuse tax under Sec. 59A. The proposed regulations did not, however, make conforming modifications in Regs. Sec. 1.1502-2 for purposes of computing a consolidated group’s tax liability.

The proposed regulations would also revise (1) Regs. Sec. 1.1502-9 to incorporate changes made by the foreign tax credit regulations (T.D. 9882) that provided guidance for statutory changes under the law known as the Tax Cuts and Jobs Act, P.L. 115-97, and (2) Regs. Secs. 1.1502-4 and -79(d) to reflect changes to the foreign tax credit carryover and carryback rules enacted since 1966.

One substantive change proposed by the regulations would withdraw proposed regulations from 2001 (REG-137519-01) as being unnecessary to prevent duplicative stock basis reductions. The 2001 proposed regulations would have clarified that Sec. 358 does not reduce stock basis for the assumption of certain liabilities described in Sec. 357(c)(3) in intercompany Sec. 351 transactions despite the general inapplicability of Sec. 357(c) to these transactions under Regs. Sec. 1.1502-80(d). As a result, there would have been a single, subsequent stock basis reduction under Regs. Sec. 1.1502-32 when the assumed liability generated a deduction.

The preamble of the new proposed regulations indicates that the withdrawal of the 2001 proposed clarification appears to shift the single stock basis reduction up front by allowing Sec. 358 to reduce the basis at the time of the Sec. 351 transaction and prevent the subsequent investment adjustment under generally applicable, existing anti-duplication rules in Regs. Secs. 1.1502-32(a)(2) and -80(a)(2).

Implications

Although the proposed changes appear to be largely nonsubstantive, these revisions would generally be a welcome update to the various consolidated return provisions that should enhance clarity and usability once finalized. For example, correcting outdated references to the former Internal Revenue Code formulas, such as the percentages applicable to computing a group’s charitable contribution deduction under Regs. Sec. 1.1502-24, and the percentages applicable to computing a group’s dividendsreceived deduction under Regs. Sec. 1.1502-26, will allow practitioners to no longer have to disregard outdated formulas in the regulations.

However, removing outdated provisions from the regulations that, by their terms, applied for only specified periods may make it more challenging to review older transactions that had been subject to the removed provisions, because the removed provisions will no longer be referred to. For example, when reviewing a target corporation’s prior-period transactions during due diligence, the absence of references in the current regulations to prior rules applicable in specified periods will necessitate locating the prior-year version of the Code for the transaction in question as well as any later versions of the regulations in which relevant retroactive changes were adopted.

Additionally, the above-mentioned withdrawal of the 2001 proposed regulations regarding the assumption of Sec. 357(c)(3) liabilities in intercompany Sec. 351 transactions and the associated preamble discussion create confusion regarding the proper application of Sec. 358 with respect to such transactions. For example, it is not clear that Regs. Sec. 1.1502-80(d) in fact alters the application of Sec. 358(d) (e.g., it might be possible to interpret Sec. 358(d)(2) as applying to liabilities described in Sec. 357(c)(3) for purposes of Sec. 358, despite Sec. 357(c) being more generally inapplicable), and the 2001 proposed regulation was described as merely a clarification of an unintended duplicative stock basis reduction that Regs. Sec. 1.1502-80(d) may produce.

Nevertheless, the preamble to the new proposed regulations appears to indicate that Regs. Sec. 1.1502-80(d) results in an up-front reduction to basis under Sec. 358 for the assumption of a Sec. 357(c)(3) liability that taxpayers must thereafter track so that the liability’s subsequent generation of a deduction does not result in a second stock basis reduction under Regs. Sec. 1.1502-32(b)(2)(i), based on the generally applicable anti-duplication provisions in Regs. Secs. 1.1502-32(a) (2) and -80(a)(2). Thus, the preamble suggests both an inappropriate tax policy result by requiring an up-front stock basis reduction under Sec. 358(d) and an administrative burden to track the assumed liability’s subsequent deduction.

Editor Notes

Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C.

For additional information about these items, contact Grais at susan.grais@ey.com.

Contributors are members of or associated with Ernst & Young LLP.