Acquisitions of Loss Companies by Consolidated Groups
Schwartzman, Randy A., Barnes, Donald A., The CPA Journal
On June 25, 1999, the IRS issued three sets of final regulations that affect the use of corporate losses by consolidated groups. These rules eliminate some of the anomalies, complexities, and overlap that existed under temporary regulations. The most prominent feature of the final regulations is the elimination of the separate return liMitation year (SRLY) rules in certain circumstances where IRC section 382 also applies. In addition, the new regulations contain rules for applying IRC section 382 to affiliated groups of companies that join or leave a consolidated group.
Because the regulations are extensive and address a wide variety of complex situations, a discussion of this nature is limited to providing only a basic overview of the new rules. A brief overview of each limitation is provided below to facilitate an understanding of the interaction of the various loss, utilization rides under the new regulations.
A SRLY loss is a loss incurred by a member of a consolidated group in a year in which the corporation filed a separate tax return or was included in a consolidated return with another affiliated group. An affiliated group that files a consolidated tax return can use a SRLY loss only to the extent that the loss corporation generates its own taxable income while a member of the consolidated group.
SRLY losses can be used to the extent of the member's cumulative contribution to consolidated taxable income since joining the group, not just the new member's contribution to current-year consolidated taxable income. This could occur when consolidated group members that are not subject to the SRLY rules have losses in excess of the income generated by the SRLY members in consolidated return years. This rule was retained from the temporary regulations.
For example, a calendar-year corporation, A, acquires an unrelated loss corporation, B, on January 1, 1908, and ,in election to file. a consolidated tax return is made in 1998.13 enters the AB group with SRLY net operating losses (NOL) of $1 mil, lion. In 1998, B had taxable income equal to $500,000 and A had a tax loss equal to $500,000. Since taxable income was zero, none of B's SRLY losses were Utilized in 1998. In 1999, A and B had taxable income equal to $500,000 each. Under these circumstances, subject to the change in ownership rules discussed below. B's entire SRLY loss of $1 million could be used to offset the AB group's taxable income of $1 million in 1999. The entire loss is allowed based on B's cumulative contribution to taxable income of St million through 1999-$500,000 in 1998 and $500.000 in 1991).
Section 382 Limitation
IRC section 392 imposes an annual limitation on the use of NOLs and other tax attributes following a change of ownership in the loss corporation of more than 50 percentage points by one or more fivepercent shareholders within a three-year period. Under IRC section 382, the corporation's NOLs incurred prior to the change of ownership can be utilized each year in an aMOUnt equal to the "IRC section 382 limitation." The IRC section 382 limitation is equal to the fair market value of the loss corporation's stock immediately before the ownership change multiplied by the Federal long-terni taxexempt rate.
Thus, for example, if the fair market value of a loss corporation is $10 million and the Federal long-term tax-exempt rate is five percent, the IRC section 382 limitation is $500,000 per year. nis would permit $500,000 of the loss corporation's NOLs to be utilized each year, subject to the general rules regarding car(ovs (i.e., the losses are limited to taxable income, utilized in chronological order, and subject to the applicable 15- or 20-year carryforward periods). If less than $500,000 of the loss corporation's losses were utilized in any year, the unused portion of the IRC section 382 limitation amount would carry over and increase the IRC section 382 limitation amount in a subsequent year. …