Consolidated Tax Services for Affiliated Corporate Groups
Explore how affiliated corporate groups can file as a single entity, a method that impacts tax liability by combining income, losses, and administration.
Consolidated tax filing allows a group of related corporations to file a single federal income tax return. Governed by Section 1501 of the Internal Revenue Code, this approach lets an affiliated group combine its income, deductions, and credits as if it were one entity. This can streamline reporting and offer strategic tax planning opportunities by presenting the business as a single cohesive unit for tax purposes.
Eligibility for Filing a Consolidated Return
To file a consolidated tax return, a group of corporations must qualify as an “affiliated group” as defined by the Internal Revenue Code. Qualification requires meeting a two-part ownership test involving a common parent corporation and other “includible corporations.” Not all corporations are includible, as the definition excludes certain tax-exempt corporations, some insurance companies, and most foreign corporations.
The requirement for affiliation is an 80% ownership rule, which considers both voting power and stock value. The common parent corporation must directly own at least 80% of the total voting power and 80% of the total stock value of at least one other includible corporation. For all other corporations in the group, stock meeting this same 80% threshold must be owned directly by one or more of the other includible corporations.
For example, if Parent Corp owns 85% of the voting power and 90% of the stock value of Subsidiary A, they can form an affiliated group. However, if Parent Corp only owns 75% of the voting power of Subsidiary B, Subsidiary B cannot be included in the group. This is because the 75% ownership falls short of the 80% voting power requirement, even if the value test is met.
Making the Consolidation Election
A group of corporations elects to file on a consolidated basis by submitting its first consolidated return by the parent’s due date, including extensions. The parent corporation files a consolidated Form 1120, U.S. Corporation Income Tax Return, on behalf of the group. This filing must include Form 851, Affiliations Schedule, which details the group’s members.
A part of the election process is securing the consent of each subsidiary. Each subsidiary must execute Form 1122, Authorization and Consent of Subsidiary Corporation to be Included in a Consolidated Income Tax Return. This form serves as a subsidiary’s formal agreement to be included in the return for the initial year.
The parent corporation is responsible for gathering all executed Form 1122 documents from its subsidiaries and attaching them to the group’s first consolidated Form 1120. The parent company must retain the original, signed copies in its records. Failure to properly file these consents can jeopardize the validity of the election, potentially requiring a request for a private letter ruling from the IRS to obtain relief.
Calculating Consolidated Taxable Income
The computation of a group’s consolidated taxable income is a multi-step process. It begins with each member corporation calculating its own taxable income or loss on a separate basis, as if filing its own return. These separate taxable income figures are then aggregated, after which a series of adjustments are made at the consolidated level to account for intercompany transactions and to combine certain tax items.
An adjustment relates to intercompany transactions, which are sales of property or services between members of the consolidated group. Gains or losses from these transactions are deferred and not recognized in the current period. For example, if one subsidiary sells an asset to another at a profit, that gain is not taxed until a “triggering event” occurs, such as the purchasing subsidiary selling the asset to an outside entity. This deferral prevents the group from recognizing income or loss from internal asset transfers.
Certain tax attributes are calculated on a group-wide basis rather than at the individual member level. Items like the net operating loss (NOL) deduction, capital gains and losses, and charitable contribution deductions are determined by netting the amounts from all members. This allows the losses of one member to offset the profits of another. For instance, an NOL generated by one subsidiary can be used to reduce the taxable income of a profitable parent company in the same year.
Ongoing Filing and Administrative Duties
Once a corporate group elects to file a consolidated return, the decision is binding for future tax years. The group is required to continue filing on a consolidated basis unless it receives permission from the IRS to stop. The administrative responsibilities for these subsequent filings are centralized with the common parent corporation.
The common parent acts as the sole agent for the group in all tax-related matters with the IRS. This means the parent handles all correspondence, files the annual return, makes tax payments, and receives any refunds on behalf of every member of the group for that tax year.
Administrative duties also include managing changes in the group’s composition. When a new corporation is acquired and meets the affiliation requirements, it must join in the consolidated return for the year it becomes a member. Conversely, when a subsidiary ceases to be a member of the group, such as through a sale, specific rules govern its departure from the consolidated filing.