How § 1.1502-80 Modifies Rules for Consolidated Returns

An affiliated group of corporations can file a consolidated tax return, combining their financial results as if they were a single company. This “single-entity” approach allows the group to offset losses from one member against the income of another and defer income from intercompany transactions. The Internal Revenue Service (IRS) provides a detailed set of rules in the Treasury Regulations to govern these returns.

Treasury Regulation § 1.1502-80 implements the single-entity theory by selectively modifying or deactivating certain Internal Revenue Code (IRC) sections for transactions between group members. This ensures that internal movements of assets and stock are not taxed like transactions with outside parties. This aligns the tax treatment with the economic reality of a unified enterprise.

Modifying Corporate Reorganization and Transfer Rules

Regulation § 1.1502-80 alters how the tax code treats transfers of corporate stock and assets between members of a consolidated group. To support the single-entity approach, the regulation makes several IRC sections inapplicable to these intercompany transactions.

Non-applicability of Section 304

Section 304 is an anti-abuse rule that prevents shareholders from extracting corporate earnings at favorable capital gains rates by re-characterizing certain stock sales between related corporations as dividend distributions.

Regulation § 1.1502-80(b) deactivates Section 304 for stock acquisitions in an intercompany transaction. Because the consolidated group is treated as one taxpayer, a stock sale between members is viewed as an internal rearrangement of assets, similar to moving cash between corporate divisions. Applying Section 304 would incorrectly create dividend income from a transaction that does not move value outside the single economic unit.

Non-applicability of Section 357(c)

Under Section 357(c), if a person transfers property and the liabilities assumed exceed the property’s tax basis, the transferor must recognize gain on the excess amount.

Regulation § 1.1502-80(d) deactivates this rule for intercompany transactions, meaning a group member can transfer assets to another member even if liabilities exceed the asset’s basis without triggering an immediate gain. The rationale is that the debt, while transferred between members, remains within the consolidated group as a whole. The group is still collectively responsible for the liability, so no gain has been realized from an economic perspective. The tax impact is instead handled by other rules that adjust the basis of the subsidiary’s stock.

Non-applicability of Section 1031

Section 1031 allows taxpayers to defer gain or loss on the exchange of “like-kind” properties, based on the theory that the taxpayer is continuing their investment in a different form.

Under § 1.1502-80(f), this tax-deferral is not available for exchanges between members of a consolidated group. The intercompany transaction rules already provide a comprehensive system for deferring gains and losses, so applying Section 1031 would be redundant. The single-entity view dictates that an exchange between two divisions of the same company is not the type of external disposition that Section 1031 was designed to address.

Adjusting Loss and Deduction Provisions

Regulation § 1.1502-80 also adjusts provisions governing loss recognition and expense deductibility. These modifications prevent the group from obtaining inappropriate tax benefits, such as duplicating a single economic loss. The changes ensure the timing of these items is consistent with the single-entity concept.

Deferral of Section 165(g) Worthless Stock Loss

Section 165(g) normally allows a shareholder to claim a loss when a corporation’s stock becomes completely worthless.

Regulation § 1.1502-80(c) defers this deduction for consolidated groups. A member cannot claim a loss on its subsidiary’s stock merely because it is financially worthless; instead, the stock is treated as worthless only when the subsidiary disposes of substantially all its assets or leaves the group. This deferral prevents loss duplication. The subsidiary’s own operating losses have likely already been used by the group to offset other income, and allowing a worthless stock deduction would create a double benefit from the same economic loss.

Non-applicability of Section 362(e)(2)

Section 362(e)(2) is a rule that prevents “loss importation.” If a shareholder contributes property with a built-in loss to a corporation, this section requires the corporation to reduce its basis in the asset to its fair market value.

For transactions between consolidated group members, § 1.1502-80(h) makes Section 362(e)(2) inapplicable. The consolidated return regulations have their own comprehensive system for dealing with duplicated losses, primarily through investment adjustment and unified loss rules. Disabling this section for intercompany transfers avoids conflicts and ensures the group’s more integrated internal basis and loss limitation rules govern the transaction.

Non-applicability of Section 163(e)(5)

Section 163(e)(5) contains the Applicable High-Yield Discount Obligation (AHYDO) rules, which can defer or disallow interest deductions on certain high-yield debt instruments.

Under § 1.1502-80(e), the AHYDO rules do not apply to an “intercompany obligation,” where both the issuer and holder are members of the same consolidated group. The policy reason is that interest payments between members have no net effect on the group’s consolidated taxable income. The paying member’s interest deduction is exactly offset by the receiving member’s interest income, so applying the AHYDO rules would create an artificial mismatch.

Interaction with Other Consolidated Return Regulations

Treasury Regulation § 1.1502-80 works with other consolidated return regulations. By disabling certain general IRC provisions, it directs the tax treatment of intercompany transactions into a specialized, integrated system that properly accounts for them under the single-entity theory.

When § 1.1502-80(b) deactivates Section 304 for an intercompany stock sale, the transaction is governed by the intercompany transaction rules of § 1.1502-13. Under these rules, the selling member’s gain or loss is deferred and tracked. The transaction is treated as a distribution from the acquiring corporation, which could be a dividend to the extent of its earnings and profits, with any excess treated as a return of capital or gain.

The effects of transactions where § 1.1502-80 applies are also captured by the investment adjustment system of § 1.1502-32. This system requires a parent company to continuously adjust its basis in a subsidiary’s stock to reflect the subsidiary’s profits, losses, and distributions. For example, when Section 357(c) is turned off, the gain that would have been recognized is instead reflected as a negative adjustment to the parent’s stock basis in the subsidiary, preventing artificial gain or loss when the parent eventually sells the stock.

The deferral of a worthless stock deduction under § 1.1502-80(c) is connected to the unified loss rules in § 1.1502-36. These rules provide a framework for addressing losses on subsidiary stock to prevent loss duplication. When a worthless stock loss is eventually allowed because the subsidiary leaves the group, § 1.1502-36 may apply to reduce the allowable loss or the subsidiary’s own tax attributes to the extent they duplicate the stock loss.