To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER CONSOLIDATED TAX RETURNS SOLUTIONS TO PROBLEM MATERIALS Question/ Problem Learning Objective LO LO LO LO LO 10 11 12 13 LO 3, LO 3, 10 LO 3, 10 LO 3, LO 3, LO LO LO 14 15 16 17 18 19 20 21 22 23 24 25 LO LO LO LO LO LO LO LO LO LO LO LO 26 27 LO LO 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 New Unchanged New New Unchanged Unchanged Modified Modified Modified Unchanged Unchanged 33 34 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-2 2012 Corporations Volume/Solutions Manual Question/ Problem Learning Objective 28 29 30 31 32 33 *34 LO 9, 10 LO LO LO 9, 10 LO 10 LO 10 LO *35 36 *37 38 39 *40 *41 *42 LO LO LO 3, LO LO LO LO LO *43 44 45 46 *47 48 49 50 *51 LO LO LO LO LO 7, LO LO LO LO 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 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 10 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Consolidated Tax Returns Question/ Problem Difficulty Est’d completion time Assessment Information AICPA* AACSB* Core Comp Core Comp Easy Medium Easy Medium 10 15 Easy 10 FN-Reporting FN-Measurement FN-Measurement | FNReporting FN-Reporting Easy Medium 10 15 FN-Reporting FN-Reporting Easy 10 FN-Reporting 10 11 12 13 14 15 Medium Easy Medium Easy Medium Easy Easy 10 10 10 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 22 Easy 23 Easy 24 Easy 25 Medium 10 26 Medium 10 27 Easy 10 28 Easy 5 8-3 FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting Communication | Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty 29 Easy 30 Easy 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 44 Easy 45 Easy 46 Medium 10 47 Medium 10 48 49 50 Easy Easy Medium 5 10 51 Medium 10 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Communication | Analytic Communication | 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-6 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS 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 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 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Consolidated Tax Returns 8-7 Event Financial Accounting Effects Tax Effects Building the consolidated report Non-U.S corporations and noncorporate entities can be included in a consolidated financial statement Only U.S corporations can be included in a consolidated tax return Affiliates to be included A greater than 50% ownership threshold is used An 80% or greater ownership threshold is used Financial Disclosure Insight, p 8-5 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Consolidated Tax Returns 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 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 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 Đ 1231 gain/loss Đ 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-16 2012 Corporations Volume/Solutions Manual Example 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 $ $ p 8-14 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 $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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 $ 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 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 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-22 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part  ... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-12 2012 Corporations Volume/Solutions Manual 19 There is no such concept as consolidated earnings and profits (E... more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-16 2012 Corporations Volume/Solutions Manual Example 35 When an affiliated group exists, Federal income tax... or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 8-6 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS One can find in