IRC 1501: Privilege to File a Consolidated Return

Internal Revenue Code (IRC) Section 1501 grants certain groups of corporations the privilege to file a consolidated income tax return. This allows a parent corporation and its subsidiaries to be treated as a single entity for federal income tax purposes, combining their incomes, deductions, losses, and credits on one return. Instead of each company filing a separate return, the group files a single Form 1120, U.S. Corporation Income Tax Return. This approach simplifies tax reporting and allows the profits of one member to be offset by the losses of another.

The election to file on a consolidated basis is made by filing the first such return, which signifies the group’s consent to be bound by the governing regulations.

Defining an Affiliated Group

Before a corporate group can file a consolidated return, it must qualify as an “affiliated group.” This status is defined under IRC Section 1504 and hinges on a parent-subsidiary relationship and stock ownership requirements. The structure requires one or more chains of “includible corporations” connected to a common parent corporation.

The definition of an affiliated group requires two ownership tests that must be continuously met. First, the parent corporation must directly own stock possessing at least 80% of the total voting power of at least one other includible corporation. Second, the parent must also own stock that equals at least 80% of the total value of the stock of that same corporation. This dual 80% vote and value test ensures a substantial and direct economic link between the parent and its subsidiary.

This ownership requirement extends down the chain. For every other corporation in the group, stock meeting the 80% vote and value tests must be owned directly by one or more of the other corporations within the group. This creates an unbroken chain of ownership from the common parent down to the lowest-tier subsidiary.

Not all corporations are eligible to be part of an affiliated group, even if the ownership tests are met. The law defines an “includible corporation” and excludes several types of entities. These include foreign corporations, most real estate investment trusts (REITs), regulated investment companies (RICs), and corporations that have elected tax-exempt status under Section 501. A group must consist solely of includible corporations, with a common parent that is also an includible corporation, to qualify.

Making the Consolidated Return Election

A group makes the election to file a consolidated return by filing its first consolidated return. This must be done by the due date of the common parent’s tax return, including any extensions, for the year the election is to be effective. A group that did not file on a consolidated basis in the previous tax year can make the election for the current year if it meets the affiliated group requirements.

A requirement for the election is the consent of every corporation that was a member of the affiliated group for any part of the tax year. Each subsidiary must agree to be included in the consolidated return by completing IRS Form 1122, “Authorization and Consent of Subsidiary Corporation to be Included in a Consolidated Income Tax Return.” The common parent corporation is responsible for gathering these forms from each subsidiary and attaching them to the group’s initial consolidated Form 1120.

Consequences of Filing a Consolidated Return

Once a group elects to file a consolidated return, the choice is binding for all subsequent tax years, and the group must continue to file on a consolidated basis as long as it exists. Permission from the IRS to deconsolidate and return to separate filings is rarely granted. It requires showing a significant change in law or circumstances that creates a substantial adverse effect on the group’s tax liability.

The common parent corporation acts as the sole agent for the entire group in all tax matters. The parent is responsible for filing the consolidated return, paying the tax, handling correspondence with the IRS, and managing any audits or tax litigation. All notices of deficiency will be sent only to the common parent, and any tax refunds are paid directly to the parent. This agency relationship centralizes all communication and responsibility.

A serious consequence is the imposition of joint and several liability on all members, as detailed in Treasury Regulations Section 1.1502-6. Every corporation that was a member of the group during any part of the consolidated return year is individually liable for the entire tax liability of the group for that year. The IRS can collect the full amount of the group’s tax debt from any single member, regardless of which company’s operations generated the tax.

This liability is not reduced by any private agreements between the members. Even if a subsidiary leaves the group, it can still be held liable for the tax debt from the years it was a member. This rule protects the government’s ability to collect taxes and underscores the legal reality that the group is a single, unified taxpayer.