1.1502-6 and Several Liability for Consolidated Groups

When a group of related corporations, such as a parent company and its subsidiaries, chooses to operate as a single entity for federal tax purposes, they file a consolidated tax return. This approach allows the group to combine its income, deductions, and credits, often resulting in a lower overall tax bill by offsetting profits in one company with losses in another. This filing decision, however, activates a rule that governs how the total tax liability is shared. This mechanism makes each member accountable for the entire group’s tax obligation for the years they are included in the consolidated filing.

The Principle of Several Liability for Consolidated Groups

The principle governing the tax obligation of a consolidated group is found in Treasury Regulation § 1.1502-6, which establishes “several liability.” This legal concept means that every corporation that was a member of the group for any part of a tax year is individually responsible for the entire federal income tax liability of the group for that year. The liability is not divided; each member is independently liable for the full tax due.

This liability is direct and primary for each member. The Internal Revenue Service (IRS) does not need to first attempt to collect the tax from the parent company or the specific member that generated the income. The IRS has the discretion to demand payment of the entire consolidated tax deficiency from any single member of the group it chooses, even if the selected member had a net loss for the year.

To illustrate, consider a parent company, P, with two wholly-owned subsidiaries, S1 and S2, that file a consolidated tax return. In that year, S1 is highly profitable, resulting in a $10 million consolidated tax liability, while P is break-even and S2 has a loss. If the group fails to pay the $10 million tax, the IRS can legally demand the full amount from P, S1, or S2, regardless of their individual financial results.

This structure prevents a situation where a profitable subsidiary’s earnings are used to offset losses, but the resulting tax liability becomes uncollectible because that entity is later sold or lacks assets. The rule ensures the tax obligation remains with every entity that benefited from the consolidated filing.

Scope of the Tax Liability

A corporation’s liability is triggered by its membership in the consolidated group for any portion of the tax year, meaning it does not need to be a member for the full 12 months. For instance, if a subsidiary is acquired and joins the group on December 30th, it becomes severally liable for the group’s tax for that entire calendar year. Similarly, a subsidiary sold on January 2nd remains fully liable for the entire consolidated tax liability for that whole year.

This creates a trailing risk for companies sold out of a consolidated group, as they carry the burden of a tax liability calculated long after their departure. The liability follows a member even after it has formally left the group. When a parent company sells the stock of a subsidiary to a third-party buyer, the former member remains responsible for the full tax liabilities of its old group for all years it was included in that group’s consolidated return.

For a buyer acquiring a company that was previously part of a consolidated group, this represents a hidden or successor liability. The acquired company could, years after the sale, receive a notice from the IRS demanding payment for a tax deficiency of its former parent’s group. This could happen in relation to a tax issue at a completely separate sister company that the acquired entity had no operational involvement with.

Managing Liability in Corporate Transactions

Given the risks of several liability, managing this exposure is a focal point when selling a subsidiary from a consolidated group. Buyers and sellers use specific contractual tools, negotiated and embedded within the legal agreements governing the transaction, to allocate and mitigate these potential tax burdens.

A common internal tool is a Tax Sharing Agreement (TSA), a formal contract among group members that dictates how the consolidated tax liability will be allocated internally. For instance, a TSA might specify that each member will pay the parent an amount equal to the tax it would have owed if it had filed a separate return. While these agreements are important for internal financial management, they have no effect on the IRS, as the governing regulation explicitly states that no private agreement can reduce any member’s several liability.

When a subsidiary is sold to an outside buyer, the stock purchase agreement becomes the primary vehicle for addressing the historical tax liability. A buyer will insist on a tax indemnification clause, where the seller agrees to reimburse the buyer for any of the consolidated group’s tax liabilities asserted against the purchased company for pre-sale periods. This makes the seller financially responsible for its group’s past tax issues.

To support the indemnification, a buyer may also negotiate for an escrow or holdback, which sets aside a portion of the purchase price to cover potential tax claims. The buyer will also require the seller to make specific tax representations and warranties in the purchase agreement. These are formal statements about the tax status and filing history of the company and its former group.

IRS Collection and Assessment Procedures

The IRS has a well-defined process for managing and collecting taxes from a consolidated group. Under Treasury Regulation § 1.1502-77, the common parent acts as the sole agent for the group in all tax matters, handling all correspondence with the IRS, filing tax returns, managing audits, and receiving any tax refunds.

When the IRS identifies a potential tax deficiency during an audit of a consolidated return, it directs all notices and communications to the common parent. The parent is responsible for handling the audit process. If a deficiency is ultimately determined, the IRS will issue a notice of deficiency and make a formal assessment for the entire amount of the underpayment by the group.

Once an assessment is made, the IRS can begin collection procedures. The government can issue a levy or file a lien against the assets of any corporation that was a member of the group during the year in question, even if that corporation is no longer part of the group. The IRS has the authority to pursue collection from a former subsidiary without first exhausting its options against the original parent company.

In situations where the original common parent no longer exists or is unable to pay, the IRS’s ability to collect from former members becomes particularly important. A provision in the regulation allows the IRS, at its own discretion, to limit its assessment against a former subsidiary to an amount allocable to that specific subsidiary, but this is not a right afforded to the taxpayer.