Solution manual SW federal taxation corporations partnerships estates and trusts 35e by hoffman chapter 08

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CHAPTER 8
CONSOLIDATED TAX RETURNS
SOLUTIONS TO PROBLEM MATERIALS

Question/
Problem

Learning
Objective

1
2

LO 1
LO 1

3
4
5

LO 2
LO 2
LO 3

6
7
8
9
10

11
12
13

LO 3, 4
LO 3, 10
LO 3, 10
LO 3, 9
LO 3, 5
LO 4
LO 5
LO 5

14
15
16
17
18
19
20
21
22
23
24
25

LO 5
LO 5
LO 5
LO 6

LO 6
LO 6
LO 6
LO 7
LO 7
LO 8
LO 8
LO 8

26
27

LO 8
LO 9

Topic
Motivations to consolidate
Events triggering a consolidation
decision
Consolidated return rules
Book versus tax treatment of affiliates
Advantages/disadvantages of
consolidating
Requirements for consolidation
Advantages of consolidation
Advantages of consolidation
Consolidated group partners
Consolidated group partners
Eligible and ineligible corporations
Compliance requirements: election

Compliance requirements:
de-consolidation
Compliance aspects
Tax allocation methods
Consolidated tax accounting
Subsidiary stock basis
Excess loss account
Consolidated E & P
Consolidated taxable income
Intercompany transactions
Intercompany transactions
NOLs used on a consolidated return
Use of NOLs
Apportioned NOLs after
de-consolidation
Consolidated NOLs
Group-basis items

Status:
Present
Edition

Q/P
in Prior
Edition

New
Unchanged

2

New
Unchanged
New

4

New
Unchanged
Unchanged
Modified
Modified
Modified
Unchanged
Unchanged

7
8
33
34
9
10
11

Unchanged
New
Unchanged
Unchanged
New
New

Unchanged
Modified
Unchanged
New
Unchanged
Unchanged
New
Unchanged

12
14
15
18
19
20
22
23
25

Instructor: For difficulty, timing, and assessment information about each item, see p. 8-3.

8-1
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8-2

2012 Corporations Volume/Solutions Manual

Question/
Problem

Learning
Objective

28
29
30
31
32
33
*34

LO 9, 10
LO 9
LO 9
LO 9, 10
LO 10
LO 10
LO 2

*35
36
*37
38
39
*40
*41

*42

LO 3
LO 3
LO 3, 4
LO 5
LO 5
LO 5
LO 5
LO 5

*43
44
45
46
*47
48
49
50
*51

LO 6
LO 6
LO 6
LO 7
LO 7, 8
LO 8
LO 8
LO 8
LO 9

Topic
Intercompany sales
Intercompany sales
Intercompany sales
NOLs and de-consolidation
Choosing not to file consolidated
Documentation requirements
Intercompany transactions: tax versus
book
Tax effects of affiliated group
Tax effects of affiliated group
Eligibility to consolidate
Tax liabilities of controlled group
Consolidated estimated taxes
Tax-sharing agreements
Tax-sharing agreements
AMT effects, separate and group basis
computation
Stock basis
Stock basis
Excess loss account
Consolidated taxable income
Consolidated taxable income
NOLS and de-consolidation
SRLY and the § 382 overlap rule
SRLY limitations
Matching rule

Status:

Present
Edition

Q/P
in Prior
Edition

Unchanged
Modified
Modified
Unchanged
New
Unchanged
Modified

26
27
28
29

Modified
Modified
Unchanged
Unchanged
Modified
Modified
Modified
Unchanged

35

36
37
38
39
40
41
42

Modified
Unchanged
Unchanged
Modified
Modified
Unchanged
Unchanged
Unchanged
Unchanged

43
44
45
46
47
48
49
50
51

31
32

*The solution to this problem is available on a transparency master.
Instructor: For difficulty, timing, and assessment information about each item, see p. 8-3.
Research
Problem
1
2
3
4
5
6
7
8
9
10

Topic
Affiliated group
De-consolidation of a consolidated group
Extending consent period
Built-in Loss
Liability for consolidated taxes
Internet activity
Internet activity
Internet activity
Internet activity
Internet activity

Status:
Present

Edition
New
Unchanged
Unchanged
New
Modified
Unchanged
New
Unchanged
Modified
Unchanged

Q/P
in Prior
Edition
2
3
5
6
8
9
10

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Consolidated Tax Returns

Question/
Problem

Difficulty

Est’d
completion
time
5

Assessment Information
AICPA*
AACSB*
Core Comp
Core Comp

1

Easy

2
3
4

Medium
Easy
Medium

10
5

15

5

Easy

10

FN-Reporting
FN-Measurement
FN-Measurement | FNReporting
FN-Reporting

6
7

Easy
Medium

10
15

FN-Reporting
FN-Reporting

8

Easy

10

FN-Reporting

9
10
11
12
13
14
15

Medium
Easy
Medium
Easy
Medium
Easy
Easy

10
10
10
5
10
10
10

16

Medium

10

FN-Reporting
FN-Reporting
FN-Reporting
FN-Reporting
FN-Reporting
FN-Reporting
FN-Measurement | FNReporting
FN-Reporting

17

Medium

10

18

Easy

19

Medium

10

20

Medium

10

21

Easy

5

22

Easy

5

23

Easy

5

24

Easy

5

25

Medium

10

26

Medium

10

27

Easy

10

28

Easy

5

5

8-3

FN-Reporting

FN-Measurement | FNReporting
FN-Measurement | FNReporting

Thinking
Analytic | Reflective
Thinking
Communication |
Analytic
Analytic | Reflective
Thinking
Analytic | Reflective
Thinking
Analytic | Reflective
Thinking
Analytic | Reflective
Thinking
Analytic | Reflective
Thinking
Analytic
Analytic | Reflective
Thinking
Analytic
Analytic
Communication |
Analytic
Analytic

*Instructor: See the Introduction to this supplement for a discussion of using AICPA and
AACSB core competencies in assessment.

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8-4

2012 Corporations Volume/Solutions Manual

Question/
Problem

Est’d
completion
time

Difficulty

29

Easy

5

30

Easy

5

31

Medium

10

32

Medium

10

33

Medium

10

34

Medium

10

35

Medium

10

36

Medium

10

37

Medium

10

38

Hard

15

39

Medium

10

40

Medium

10

41

Medium

10

42

Medium

10

43

Easy

5

44

Easy

5

45

Easy

5

46

Medium

10

47

Medium

10

48
49
50

Easy
Easy
Medium

5
5
10

51

Medium

10

Assessment Information
AICPA*
AACSB*

Analytic
Analytic | Reflective
Thinking
Communication |
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic

*Instructor: See the Introduction to this supplement for a discussion of using AICPA and
AACSB core competencies in assessment.

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Consolidated Tax Returns

8-5

CHECK FIGURES
34.b. LittleCo, no effect.
34.c. Big, $150,000 gain.
35.a. Separate, $1 million DRD is allowed.
35.c. Consolidated, Giant and PebbleCo are
both fully liable for $170,000 of tax.
36.b. Deduction in both cases is deferred until
gross income year.
36.d. Consolidated, the members must make
same election as to foreign tax
payments.
37.c. Controlled group, not affiliated.
38.
Senior is liable for $2.5 million.
39.
Parent remits $1,050 for 2013.
40.
$255 allocated to Parent.

41.
42.

$280 allocated to Parent.
Consolidation reduces group liability

$22,500.
43.a. $37 million basis, end of 2011.
43.c. $15 million ELA, end of 2011.
44.
$200,000 end of year 2.
45.
$100,000 excess loss account.
46.
$10,000 for 2012.
47.
2010 $300,000; 2011 $140,000.
48.
$1 million NOL carryforward.
49.
$400,000.
50.
NOL deduction in 2011 = $500,000.
51.a. Consolidated taxable income $110,000.
51.b. Consolidated taxable income $210,000.

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8-6

2012 Corporations Volume/Solutions Manual

DISCUSSION QUESTIONS

1.

One can find in the marketplace various motivations to consolidate corporate holdings in such
a way that a consolidated return is attractive.
•

The isolation of the assets of one corporation for the liabilities of another.

•

The execution of estate planning objectives.

•

A perceived value of retaining the separate identities of the acquired corporation.

•

A need to shield the identities of a subsidiary’s true owners from the public.

•

A desire to optimize negotiations with labor unions, suppliers, or governmental units.

pp. 8-2 and 8-3
2.

A consolidation election may be available as a result of various business decisions.
•

A merger, acquisition, or other corporate combination.

•

A structural change in the capital of a corporation due to regulatory requirements,
competitive pressures, or economizing of operations.

•

A desire to gain tax or other financial advantages.

pp. 8-3 and 8-4
3.

Delegation of tax-writing authority to the Treasury may be a necessary evil in the realm of the
consolidated return. The length and detail of the rules associated with consolidated returns
makes them poorly suited for placement in the Code. Moreover, as corporate structures and
transactions become more complex every year, development of the expertise that Treasury
staffers (and the tax professionals that assist them) use to draft the Regulations is critical. As
long as the public review process for the consolidated return Regulations remains thorough,
the current situation may be the best solution possible. pp. 8-4 and 8-5

4.

Some of the more important differences between the book and tax treatments of
conglomerates include the following.
Event

Financial Accounting Effects

Tax Effects

Acquiror takes
over Target

The transaction is treated as a
purchase, with cost amounts
marked up or down to fair market
value (FMV).

Depends upon the structure of the
deal. Nontaxable with carryover
basis if a qualifying reorganization
(see Chapter 7) or a stock
purchase. If an asset purchase, a
FMV tax basis is taken.

Purchase price
exceeds the sum
of the net assets
acquired

Goodwill is created. No scheduled Goodwill is created. Purchased
amortization. Impairments or
goodwill usually is amortized into
restorations of goodwill are
taxable income over 15 years.
recorded on the income statement
and balance sheet.

A greater than 50% ownership
threshold is used.

An 80% or greater ownership
threshold is used.

Financial Disclosure Insight, p. 8-5
5.

SPEECH OUTLINE
November 3, 2011
WHEN TO USE CONSOLIDATED RETURNS
Potential Advantages of Filing Consolidated Returns
•

Use the operating and capital loss carryovers of one group member to shelter the
corresponding income of other group members.

•

Eliminate taxation of all intercompany dividends.

•

Defer recognition of income from certain intercompany transactions.

•

Optimize certain deductions and credits, by using consolidated amounts in computing
pertinent limitations.

•

Increase the tax basis of investments in the stock of subsidiaries by the amount of positive
subsidiary taxable income.

•

The domestic production activities deduction (§ 199) of a group might be greater than the
sum of the deductions for all of the affiliates, as the formula for the deduction is optimized
under the statute.

•

Use the alternative minimum tax (AMT) attributes of all group members in deriving
consolidated alternative minimum taxable income (AMTI), thereby reducing the
magnitude of the adjustment for adjusted current earnings (ACE) and of other AMT
preferences and adjustments.

•

Use the current-year operating losses of one group member to defer or reduce the (regular
or AMT) estimated tax payments of the entire group.

Potential Disadvantages of Filing Consolidated Returns

•

Binding nature of the election on all subsequent tax years of the group members, unless
either the makeup of the affiliated group changes, or the IRS consents to a ‘‘deconsolidation.”

•

Apply the capital and operating losses of one group member against the corresponding
income of the other group members when assignment of such losses to separate return
years would produce a greater tax reduction therefrom.

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8-8

2012 Corporations Volume/Solutions Manual
•

Defer recognition of losses from certain intercompany transactions.

•

Decrease the amounts of certain deductions and credits, by using consolidated amounts in
computing pertinent limitations.

•

Decrease the tax basis of investments in the stock of subsidiaries by the amount of
negative subsidiary taxable income, and by distributions therefrom.

•

Creation of short taxable years of subsidiaries, in meeting the requirement that all group
members use the parent’s tax year, thereby bunching income and expending one of the
years of the subsidiary’s charitable contribution and loss carryforward period.

•

Recognition of legal and other rights of minority shareholders in the context of a
consolidated group.

•

Incurring of additional administrative costs in complying with the consolidated return
regulations.

pp. 8-6, 8-7, and Concept Summary 8.1
6.

Before a consolidation election can be made under the tax law, three major requirements first
must be met.
•

Affiliated group status

Stock ownership tests
Identifiable parent corporation

•

Eligible corporation to join

consolidated group

Statutory definitions

•

Compliance requirements

Forms 851, 1122
Conformity to parent’s tax year

pp. 8-8, 8-12, 8-13, and Concept Summary 8.1
7.

Pertinent tax issues include the following.
•

How accurate are the income and loss projections of the group members?

•

Will Black’s NOLs be available for deduction against future group taxable income?

•

Will Black’s NOLs be available for immediate carryback, producing a tax refund in the
near future?

•

Will Red produce net taxable income at levels that will accelerate the use of Black’s
NOLs?

•

Will Red begin to produce new NOLs in the future?

•

Will Red’s new NOLs be deductible against group taxable income?

pp. 8-6 to 8-8

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Consolidated Tax Returns
8.

8-9

Additional pertinent tax issues include the following.
•

How will the group charitable contribution deduction be computed in the future?

•

Will all of Brown’s charitable gifts be deductible against group taxable income
(i.e., considering the 10% floor on a group basis)?

•

How will the group’s § 1231 gain or loss be computed in the future?

•

How will Brown’s realized gain and loss affect the group’s § 1231 netting and
computation in the future?

Example 6
9.

Finding good consolidated return partners often means that contrary tax effects are matched
together, resulting in a lower total Federal income tax.
a.

Probably a good match. Intercompany gains are deferred until a sale is made to a
taxpayer outside of the consolidated group.

b.

Probably not a good match. The parties want to accelerate recognition of the realized
losses, and consolidation results in the deferral of those losses.

c.

Probably not a good match. Tax return elections made by the parent of a consolidated

group are binding on all members of the filing group for the tax year.

d.

Probably not a good match. SubTwo must convert to a calendar tax year upon joining
the ParentCo consolidated group, and this may result for the group in a bunching of
more than twelve months of taxable income into the calendar year of the election.

Example 6
10.

Finding good consolidated return partners often, but not always, means that contrary tax
effects are matched together, resulting in a lower total Federal income tax.
a.

Probably a good match, especially if the affiliated group’s domestic production
activities deduction (DPAD) is greater than the sum of Parent’s and SubCo’s DPAD.

b.

Perhaps not a good match. The election to consolidate cannot be “turned on and off.”
The election is binding on all future tax years, and this may not be a desirable result if
both affiliates generate a positive taxable income. If an election is made and approved
to “de-consolidate,” the same group cannot re-elect consolidated status for five years.

c.

Probably a good match, depending on the current marginal tax rates of the group
members. If consolidation occurs, ShortCo’s foreign-source income could be used to
free up the foreign tax credit carryforwards, resulting in immediate tax reductions.

d.

Probably not a good match. An attractive consolidated return partner would allow
ParentCo to shelter some of its Federal taxable income, and Small will produce such
losses for only one tax year. Moreover, after a de-consolidation, the group probably
could not re-elect to form a group again for five tax years, so planning flexibility
would be lost.

Example 6
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8-10
11.

2012 Corporations Volume/Solutions Manual
The consolidated return rules general produce these results.

Group of Entities
a. Mercy Hospital
b. Columbus United
Health Insurance,
Ltd.
c. Bethke Services, Inc.
d. Tequila Telefono,
organized in El
Salvador

e. Vermont, South
Carolina, and Utah
Barber Shops, Inc.

Eligible to Join a
Consolidated
Group?
No
No
Yes
No

Why or Why Not Eligible?
Exempt entities are ineligible
to join a consolidated group
Insurance companies are
ineligible to join a
consolidated group
Non-U.S. entities are
ineligible to join a
consolidated group

Yes

f. Boston Yankees
Partnership

No

g. Henry Pontiac Trust

No

Non-corporate entities are
ineligible to join a
consolidated group
Non-corporate entities are
ineligible to join a
consolidated group

pp. 8-12 and 8-13
12.

In most cases, the decision to consolidate must be made no later than the extended due date of
the parent’s return for the year. Here, that date is September 14, 2012. p. 8-13

13.

Terminations must be applied for at least 90 days prior to the extended due date of the
consolidated return. Here, that date is June 18, 2012. pp. 8-13 and 8-14

14.

a.

The first consolidated tax return for Lavender and Azure is due. Forms 851 and 1122
are attached.

b.

Separate company estimated payments are still allowed as the third year has not yet
been reached.

c.

The results of Rose’s tax year are included in the group return. The Form 851 now
includes Rose, but no additional Form 1122 need be filed.

d.

The first date upon which an election to re-form the Lavender Azure and Rose group
would be allowed, lacking IRS permission. This is after five tax years pass since Rose
left the group.

Filing dates can be extended, or Rose might not elect immediately to be included in the group.
The two-year rule for estimated taxes cannot be extended by taxpayer election, and it is
difficult to get the IRS to shorten the five-year waiting period.
pp. 8-13 and 8-14

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Consolidated Tax Returns
15.

8-11

Under the relative taxable income method, the consolidated tax liability is allocated among

the members based on their amounts of separate taxable income.
When the relative tax liability method is used, the allocation is based on the hypothetical
separate tax liabilities of the affiliates.
p. 8-15 and Example 16

16.

Members of a consolidated group must use the same tax year-end, but they can retain
differing accounting methods. The $5 million gross-receipts test is applied on a group basis,
so Child may be forced to switch to the accrual basis of accounting. However, personal
service corporations can elect to avoid such a switch. If Child is found to be in such an
industry and the cash method remains desirable, this election may be attractive. But the list in
§ 448(d)(2)(A) seems to preclude the group from making the election to keep Child’s cash
basis method. pp. 8-16, 8-17, and Table 8.1

17.

TAX FILE MEMORANDUM
November 3, 2011
To:

Tax File, Jeri Byers

From: Mandy Michael
Re:

Adjustments to subsidiary stock basis

Positive Adjustments
•

Consolidated taxable income

•

Unused operating or capital loss

Negative Adjustments
•

Consolidated taxable loss

•

Operating and capital losses, used or carried back this year, if not previously deducted
from basis

•

Dividends paid to parent out of E & P

p. 8-17
18.

A parent’s stock basis in a consolidated subsidiary never can go below zero. But when
negative adjustments exceed the stock basis in the subsidiary, an excess loss account is
created, in the amount of the negative adjustments. This means that annual operating and
other losses of the subsidiary can continue to be deducted on the consolidated return; their use
is not suspended as would be the case with partnerships and S corporations (see Chapters 10
and 12, respectively).

If the subsidiary stock is sold or redeemed by the parent when an excess loss account exists,
the parent typically recognizes the balance of the account as capital gain.
p. 8-18

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8-12

2012 Corporations Volume/Solutions Manual

19.

There is no such concept as consolidated earnings and profits (E & P) in the Federal income
tax law. The subsidiaries keep track of their respective E & P balances on a pre-consolidated
basis, as does the parent. A subsidiary’s E & P records its own operating results, and it makes
E & P adjustments for its agreed-upon share of the consolidated Federal income tax liability.
E & P of the subsidiary also reflects any gain/loss on intercompany transactions with other
affiliates. p. 8-18

20.

Consolidated taxable income is derived using the following step-wise computational method.
•

Compute taxable income for each affiliate on a separate basis, applying the usual rules of
Subchapter C and the rest of the Code.

•

Remove from each affiliate’s separate taxable income any group items.

•

Remove from each affiliate’s separate taxable income the tax effects of any intercompany
transactions.

•

Account for any intercompany distributions and permanent eliminations from
consolidated taxable income.

•

Use the combined amounts from all affiliates to compute the effects on consolidated
taxable income of each of the identified group items. Add these positive or negative
amounts back to taxable income (or the amount of the AMT base).

•

Isolate the effects of intercompany transactions on consolidated taxable income.

•

Combine all of the pertinent amounts into consolidated taxable income.

p. 8-18 and Figure 8.1
21.

Parent is attempting to gain a timing advantage with its consolidated tax liability, by
“mismatching” its own 2011 recognition of gross income from the service contract with a
2012 deduction by Child. Parent’s own NOL situation for the year makes attractive such a net
income acceleration for the group.
Unfortunately for the group, §§ 267(a)(2) and (b)(3) instead force a matching of the two
events. The deduction is claimed in the year of gross income recognition (here, 2011), and the
net result to the group is an addition to consolidated taxable income of zero, in both tax years.
p. 8-20

22.

Parent is attempting to accelerate the deduction for the common services into 2011, while
recognizing its associated gross income only in 2012. Unfortunately for the group,
§§ 267(a)(2) and (b)(3) force a matching of the two events. The deduction is claimed in the
year of gross income recognition (here, 2012), and the net result to the group in that year is a
zero change in consolidated taxable income, in both tax years. p. 8-20

23.

Perhaps not. At most, only $1,500,000 of Tiny’s NOL carryforward can be used in the first
tax year, which is that entity’s cumulative contribution to consolidated taxable income. Then,
§ 382 may reduce that deduction. Figure 8-3

24.

Under the so-called offspring rule, a consolidated group can carry back a loss that is
apportioned to a group member that did not exist in the carryback year, where the new
corporation’s existence is rooted in the parent’s assets (e.g., due to a divisive reorganization

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Consolidated Tax Returns

8-13

similar to that which created Junior). If the member joined the group immediately upon its
incorporation, the group can use the loss. Reg. §1.1502-79(a)(2)
Thus, if Junior consents to join the consolidated group, its $500,000 apportioned NOL is
available for carryback and can create a refund for the group. If Junior does not join the group
this year, the SRLY rules will restrict the use of the NOL to carryforwards related to the
income contributions of Junior to the group after its consent is received. Example 26
25.

When a member leaves a consolidated return group, it takes with it the net operating loss
carryforwards that are apportioned to it. Thus, assuming that § 382 limitations do not restrict
the deduction, White will report a zero taxable income on its first two separate Forms 1120,
and $100,000 on the third. The NOL carryforwards apportioned to Beige remain with the
parent and any newly formed consolidated group. Example 27

26.

The separate return limitation year (SRLY) rules defer the deduction for the net operating
losses of an affiliate until that corporation contributes positively to consolidated taxable
income. The SRLY rules are intended to prevent a “trafficking” in the net operating losses of
unsuccessful corporations, which might be acquired merely to obtain the NOL deductions.
The SRLY rules attempt to keep an existing group from reducing consolidated taxable income

by using current loss deductions that are traceable to an affiliate’s operations prior to its
joining the consolidated group. The new affiliate’s NOLs are allowed, but only after that
affiliate makes positive contributions to the taxable income of the group.
SRLY rules are overridden to the extent that there is a § 382 limitation on NOL deductions for
the group (see Chapter 7).
pp. 8-25 and 8-26

27.

A consolidated group computes the following items on a group basis when filing its tax
return, among others.
•

Net capital gain/loss

•

§ 1231 gain/loss

•

§ 199 domestic production activities deduction

•

Casualty/theft gain/loss

•

Charitable contributions

•

Dividends received deduction

•

Net operating loss

•

Various credits and their recapture

•

Percentage depletion deduction

•

AMT exemption, preferences, and adjustments

p. 8-27
28.

a.

The matching rule generally defers gain/loss recognition until an asset is sold outside
of the consolidated group. The matching rule applies a ‘‘one company with multiple

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8-14

2012 Corporations Volume/Solutions Manual
divisions” approach to intercompany transactions. The acceleration rule applies when
the matching rule is inappropriate, triggering immediate recognition of the gain/loss.
b.

Most taxpayers prefer to apply the matching rule to gains and the acceleration rule to
losses.

p. 8-30
29.

The only reflection of these transactions in consolidated taxable income is in Year 4, when the
total $60 gain is recognized. The matching rule defers the Year 3 realized gain, as though it
were a sale between divisions of one corporation. p. 8-30 and Example 34

30.

The only reflection of these transactions in consolidated taxable income is in Year 4, when the
total $60 loss is recognized. The matching rule defers the Year 3 realized loss, as though it
were a sale between divisions of one corporation. The matching rule is designed to prevent
group members from accelerating loss deductions that are realized within the group. p. 8-30
and Example 34

31.

TAX FILE MEMORANDUM
August 4, 2011
To:

File—Pro-Junior version

Re:

Client Junior’s Deferred Loss

Facts

When Junior left the Rice consolidated group, it left behind a $600,000
deferred loss from intercompany sales.

Issue

Can Junior take the loss with it and use it on subsequent separate returns?

Conclusion

Junior may have a claim to the loss if ownership levels change such that it no
longer is a member of the Rice controlled group.

Reasoning

Deferred losses remain with the group when the corporation that generated the
loss leaves the group, if the departing member remains part of the electing
entities’ controlled group [§ 267(f)]. It is unlikely that the group will allow

Junior to take the loss without some offsetting compensation.

TAX FILE MEMORANDUM
August 4, 2011
To:

File—Pro-Rice version

Re:

Client Junior’s Deferred Loss

Facts

When Junior left the Rice consolidated group, it left behind a $600,000
deferred loss from intercompany sales.

Issue

Can Junior take the loss with it and use it on subsequent separate returns?

Conclusion

The loss remains with the group, because Junior is still a member of the Rice
controlled group and § 267(f) prohibits the related party loss deduction, even
after Junior leaves the electing consolidated group.

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Consolidated Tax Returns
Reasoning

8-15

The asset still is held by the group, and gain recognition is controlled by
whether the asset leaves the group’s ownership.

p. 8-30
32.

A parent might prefer to avoid the consolidation election when:
•

An affiliate is organized outside the U.S.

•

An affiliate is an insurance company.

•

An affiliate brings undesired tax attributes to the group, like a sizable balance in its E & P.

•

There is a greater tax benefit in merely claiming a dividends received deduction for
payments among group members.

•

Compliance and administrative costs associated with the consolidated return election are
excessive.

p. 8-31
33.

The required documentation includes the following items, among others, when an affiliate is
considering whether to join a consolidated tax return group.
•

Tax liability sharing methods that the affiliates adopt.

•

Means by which the tax liability sharing methods can be changed.

•

Sharing of the tax liabilities (income taxes and others) that result from the takeover itself.

•

Initial Huge basis in the Findlay stock.

•

Responsibilities of the parties as to annual (or more frequent) maintenance of the Findlay

stock basis.

p. 8-32
PROBLEMS
34.

Tax and book treatment of intercompany transactions are similar but not identical.
Transaction
Little pays a $1 million
dividend to Big
Little sells an asset at a gain
to Big
Big sells the intercompanysale asset to an outsider

Financial Accounting
Treatment

Consolidated Tax Return
Treatment

Consolidated eliminating
entry — No effect on
book income
No effect

Consolidated eliminating
entry — No effect on taxable
income
No effect

Big reports $450,000 gain LittleCo recognizes
$300,000 gain. Big
recognizes $150,000 gain.

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8-16

2012 Corporations Volume/Solutions Manual
Example 5

35.

When an affiliated group exists, Federal income tax treatment often changes for the group
members.
Item

If Consolidated Return Is Filed

If Separate Returns Are Filed

a.

The payment is eliminated in dividend
computing consolidated taxable
income, so no tax liability results.
Only one 15% tax bracket is allowed

to the affiliated group, so total Federal
income tax is $22,250. An allocation
method is used to determine the
payment of each member.
Both corporations are fully liable for
the $170,000 income tax liability. An
allocation method is used to determine
the payment of each member.
No restriction. A parent and
subsidiary are allowed to use different
tax accounting methods.

Giant reports $1 million in income, then
claims a $1 million (100%) dividends
received deduction.
Only one 15% tax bracket is allowed to
the controlled group, so total Federal
income tax is $22,250.

b.

c.

d.

Giant is liable only for its $95,000
liability, and PebbleCo for its $75,000.
No restriction. A parent and subsidiary
are allowed to use different tax
accounting methods.

Table 8.1
36.

When an affiliated group exists, Federal income tax treatment often changes for the group
members.
Situation

If Consolidated Return is
Filed

If Separate Returns are Filed

a. Giant and PebbleCo
both produce taxable
profits from
manufacturing
activities.

The § 199 DPAD is
computed on a group basis
and deducted on the
consolidated return.

The § 199 DPAD is computed
separately for both Giant and
PebbleCo.

b. PebbleCo pays Giant
an annual royalty for

use of the Giant
trademarks.

The deduction and income
items both are reported in
the year of Giant’s income
recognition. On the
consolidated return, they
net to zero.

The deduction and income
items both are reported in the
year of Giant’s income
recognition.

c. Giant uses a calendar
tax year, while
PebbleCo’s tax yearend is March 31.

PebbleCo must convert to a Pebble can retain its fiscal tax
calendar tax year,
year.
immediately upon joining
the Giant consolidated
group.

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Consolidated Tax Returns

8-17

Situation

If Consolidated Return is
Filed

If Separate Returns are Filed

d. Giant claims a credit
for its foreign tax
payments, while Pebble
claims a deduction for
them.

The affiliates must make
the same election as to
foreign tax payments, and
the amounts are computed
on a group basis.

The affiliates can continue to
make different elections as to
foreign tax payments.

Table 8.1
37.

The 80% test is failed in a. In b., stock attribution rules apply in identifying a controlled
group, but not an affiliated group. In c., the affiliated group test must be met on every day of
the tax year, while the controlled group test must be met only on the last day of the year.
Situation

Facts

Parent-Subsidiary
Controlled Group?
(Y/N)

Affiliated Group?
(Y/N)

a.

Throughout the year, P
owns 65% of the stock of S.

N

N

b.

Parent owns 70% of SubCo.
The other 30% of SubCo
stock is owned by Senior, a
wholly owned subsidiary of

Parent.
For 11 months, P owns 75%
of the stock of S. For the
last month of the tax year, P
owns 100% of the S stock.

Y

N

Y

N

c.

pp. 8-8, 8-9, and 8-12
38.

Senior must pay the $2.5 million for Junior’s Federal income taxes, as consolidated return
partners have joint and several liability as to income taxes due. The bankruptcy receiver will
determine the ultimate disposition of the $1 million owed to the supplier, but Senior is not
likely to have any responsibility for paying that obligation. p. 8-14

39.

Consolidated tax estimates are not required of the group until its third tax year under the
election. Lacking an agreement to the contrary, Sub makes its own estimates for 2010 and
2011.
Year Parent Remits ($000) Sub Remits ($000)

2010
2011
2012
2013

$ 500
$ 500
$ 800
$1,050

$150
$170
$ 0
$ 0

p. 8-14

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8-18
40.

2012 Corporations Volume/Solutions Manual
Consolidated tax liabilities are shared in the following manner.
Separate Taxable Allocation
Income
Ratio

Parent
SubOne
SubTwo
SubThree
Totals

$ 850
200
150
–0–
$1,200

Allocated Tax
Due

850/1,200
200/1,200
150/1,200
0

$255
60
45
–0–
$360

Example 16
41.

Consolidated tax liabilities are shared in the following manner.

Separate
Taxable
Income

Separate Tax
Liability

Allocation
Ratio

Allocated
Tax Due

Parent
SubOne

$ 850
200

297.5/400
50/400

$268
45

SubTwo
SubThree
Totals

150

–0–
$1,200

$297.5
50, after
applying energy
tax credit
52.5
–0–
$400

52.5/400
0

47
–0–
$360

Example 16
42.

ACE Adjustment = .75(ACE – Pre-ACE AMTI)
Without consolidation

As consolidated

ParentCo
DaughterCo
Group

.75($500,000) = $375,000
$0 [Negative $112,500 [.75($150,000)]
adjustment is wasted]
$375,000

Group

.75($350,000) = $262,500

The unused “negative” ACE adjustment of $112,500 generated by DaughterCo is used by the
group when a consolidation election is in force.
AMT Exemption
The affiliates share one exemption, but because of the phaseout percentages, the exemption
becomes zero whether or not a consolidation election is made.
Thus, the election to consolidate benefits the group overall by reducing the group liability by
$22,500 ($112,500 reduction in aggregate ACE adjustment × 20% AMT), in a manner
traceable to the computation of the ACE adjustment.
p. 8-16 and Chapter 3

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Consolidated Tax Returns
343.

Stock Basis at
End of Year

8-19

Alternative A

Alternative B

Alternative C

2010
2011

$34 million
$37 million

$34 million
$19 million

2012

$52 million

$34 million

$34 million
$15 million Excess Loss
Account
$ 0 stock basis and
Excess Loss
Account

If a subsidiary is sold while its parent holds an Excess Loss Account in it, capital gain income
is created to the extent of the account balance.
pp. 8-17, 8-18, and Examples 18 and 19
44.

The stock basis in a subsidiary is adjusted at the end of every tax year in a manner similar to
that of the financial accounting “equity” method. Stock basis cannot go below zero, so an excess
loss account is created when negative adjustments exceed the beginning-of-year stock basis.
Tax Year
1
2
3

Operating Gain/(Loss)
$100,000
($400,000)
($300,000)

Stock Basis
$500,000 + $100,000 = $600,000
$600,000 – $400,000 = $200,000
$0 with a $100,000 excess loss
account ($200,000 – $300,000)

pp. 8-17, 18-18, and Examples 18 and 19
45.

If subsidiary stock is sold while its parent holds an excess loss account in it, capital gain
income is created equal to the extent of the account balance.
Amount realized from stock sale

– WhaleCo basis in MinnowCo stock
+ Excess loss account
Capital gain income

$250,000
(–0–)
100,000
$350,000

pp. 8-17, 8-18, and Example 19
46.

Consolidated taxable income is computed as follows.
2010

$200,000

2011

190,000

2012

10,000

2013

340,000

The Orange losses offset the Teal income dollar for dollar, but they never become large

enough to produce a consolidated taxable loss. Because both corporations produce ordinary
income, there are no adjustments to make using the format of Figure 8.2. There are no
consolidated NOL carryovers in any of the specified years.
Example 21

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8-20
47.

2012 Corporations Volume/Solutions Manual
It is assumed that the group does not elect to forgo the carryback of the 2012 consolidated net
operating loss.
Consolidated taxable income
2010

$300,000

2011

140,000

2012

0

2013

325,000

($150,000) NOL carryback. This generates a partial refund of the 2010
group tax liability. The 2012 NOL is fully used.

Example 23
48.

In years when a group member files a separate return (e.g., due to a de-consolidation of the
member from the group), each member can carry over only its apportioned segment of the
group NOL. Thus, Ocelot can use its $1 million share of the group NOL carryforward on its
2011 separate return. Figure 8.3

49.

The NOL deduction is limited to $400,000, the annual § 382 amount. The § 382 provisions
prevail over those of the SRLY rules when both restrictions apply. Example 30 and Chapter 7

50.

Under the SRLY rules, the group cannot carry back the losses that Child brings into the
group. Subsequent deductions are limited to the cumulative positive contributions toward
group taxable income that are traceable to Child. Child’s NOL can be deducted by the Thrust
group as follows.
2010. . . . . . $0

2011. . . . . . $500,000

2012. . . . . . $400,000 (exhausted)

Figure 8.3
51.

a.

This intercompany transaction is subject to the matching rule. Realized gain is
deferred, through an elimination in the computation of consolidated taxable income.
The $80,000 gain is recognized when SubCo later sells the land to Outsider.

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Consolidated Tax Returns

Separate
Taxable Income
ParentCo
$210,000
Information
SubCo Information
Group-Basis
Transactions
Intercompany
Events

8-21
PostAdjustment

Amounts

Adjustments

$210,000
($ 20,000)

($ 20,000)
– $80,000 Gain on
intercompany sale
to SubCo †

Consolidated
Taxable Income

($ 80,000)
$110,000

NOTES
† Matching Rule
b.

The solution includes the $10,000 post-acquisition gain realized and recognized by
SubCo on the land.
Separate
Taxable
Income
ParentCo
Information
SubCo Information

Group-Basis
Transactions
Intercompany
Events
Consolidated
Taxable
Income

Adjustments

Post-Adjustment
Amounts

$90,000

$ 90,000

$40,000

$ 40,000
– $80,000 Restore
gain on
ParentCo’s Sale to
SubCo †

+ $ 80,000

$210,000

NOTES

† Matching Rule
Example 34

The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture
Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION:
CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS.

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8-22

2012 Corporations Volume/Solutions Manual
NOTES

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Solution manual SW federal taxation corporations partnerships estates and trusts 35e by hoffman chapter 08

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