What Are the 1502-13 Intercompany Transaction Rules?

Federal tax law allows affiliated corporations to file a single, consolidated tax return. To prevent groups from artificially altering their tax liability through internal dealings, the IRS established regulations under Treasury Regulation § 1.1502-13. These rules govern “intercompany transactions” to reflect the taxable income of the entire group as if it were a single economic unit. They neutralize the tax effects of internal transactions by preventing members from creating or accelerating income or losses until a transaction occurs with an entity outside the group.

The Single Entity Approach and Core Definitions

An “intercompany transaction” is any transaction between corporations that are members of the same consolidated group immediately after it occurs. This can include the sale of property, the performance of services, or the lending of money. The regulations label the member transferring property or providing services as “S” (the selling member) and the member receiving the property or services as “B” (the buying member).

S’s gain or loss from the transaction is its “intercompany item.” For instance, if S sells land to B, the gain S calculates on that sale is its intercompany item. This item is not immediately reported on the consolidated tax return; its timing is determined by the activities of B.

B’s subsequent accounting for the asset or service gives rise to “corresponding items.” A corresponding item is B’s income, gain, deduction, or loss related to the intercompany transaction or the property acquired in it. If B later sells the land it bought from S to an outside party, B’s gain or loss on that second sale is a corresponding item. If the asset were a depreciable machine, B’s annual depreciation deductions would also be corresponding items.

The Matching Rule

The Matching Rule dictates the timing and character of both S’s intercompany items and B’s corresponding items. It links the two sides of the transaction by deferring S’s intercompany item until B takes its corresponding item into account. This ensures the net result on the group’s consolidated taxable income is the same as if S and B were divisions of a single corporation.

The timing is governed by a specific formula. Each year, S must take into account its intercompany item to the extent of the difference between B’s actual corresponding item and the “recomputed corresponding item.” The recomputed corresponding item is what B would have recognized if S and B were divisions of a single company and the transaction was a transfer between those divisions. This means B would have taken the asset with the same tax basis that S originally had.

For example, S holds land with a tax basis of $70,000 and sells it to B in Year 1 for its fair market value of $100,000. S’s intercompany item is a $30,000 gain. In Year 3, B sells the land to an unrelated party, X, for $110,000, resulting in B’s corresponding item, a $10,000 gain.

To determine when S reports its $30,000 gain, we calculate the recomputed corresponding item. If S and B were divisions of one company, the basis in the land would have been S’s original $70,000, and the sale to X would have produced a total gain of $40,000. S must recognize its intercompany gain equal to the recomputed item ($40,000) minus B’s actual corresponding item ($10,000), which equals $30,000. Both items are recognized in Year 3.

The Matching Rule also governs the “attributes” of the items, such as whether a gain is capital or ordinary. The attributes of S’s and B’s items are redetermined to produce the same effect as if the transaction occurred between divisions of a single corporation. In the land sale example, if both S and B held the land for investment, both S’s $30,000 gain and B’s $10,000 gain would be treated as capital gain.

The Acceleration Rule

When treating the selling member (S) and buying member (B) as divisions of a single entity is no longer possible, the Acceleration Rule is triggered. This rule forces S to take its remaining deferred intercompany items into account immediately, severing the link to B’s corresponding items.

The most common trigger is when either S or B ceases to be a member of the consolidated group. For example, if the parent company sells the stock of S to an unrelated buyer, S is no longer part of the group. The Acceleration Rule requires S to recognize its entire deferred gain immediately before it leaves the group.

Another trigger occurs if the property is transferred outside the group in a way that prevents future matching. For instance, if B contributes an asset it bought from S to a partnership, the asset is now held by a non-member. Because it is no longer possible to treat S and B as divisions of a single entity with respect to that asset, S’s deferred gain or loss would be accelerated.

When an intercompany item is recognized under the Acceleration Rule, its character is determined as if B had sold the property for its fair market value to a non-member immediately before the accelerating event occurred. This ensures the character reflects the economic activities of the group up to that point.

Intercompany Transactions Involving Member Stock

Special provisions exist for intercompany transactions involving the stock of a member corporation. These rules address the complexities that arise when the asset being bought and sold is ownership in another group member.

One of the most significant rules relates to intercompany distributions. When one member pays a dividend to another member that owns its stock, the dividend income is excluded from the recipient’s gross income. This prevents the group’s income from being increased by the movement of cash or property from a subsidiary to its parent.

Other rules address situations where member stock is transferred or eliminated in transactions like corporate liquidations or reorganizations. For example, if a parent company liquidates a subsidiary it owns, any gain or loss the parent might have recognized on the subsidiary’s stock is generally not taken into account. The regulations treat such a transaction as if the subsidiary’s assets were transferred directly to the parent within a single entity.

Intercompany Transactions Involving Member Obligations

Debt obligations between members of a consolidated group are subject to a unique set of rules. The lending and borrowing of money between members can create offsetting positions where one member’s asset (a receivable) is another member’s liability (a payable). The rules ensure that any gain, loss, income, or deduction from these obligations nets to zero on the group’s consolidated return.

The core of these rules is a “deemed satisfaction and reissuance” model. This model is triggered when a member realizes an item of income or loss from an intercompany obligation, or when an obligation held by one member becomes an intercompany obligation. The regulation treats the obligation as if it were first satisfied for its fair market value and then, if it remains outstanding, immediately reissued as a new obligation for that same value.

For example, S lends $1 million to B. Later, the parent company, P, purchases this note from S for $980,000, its current fair market value. This triggers the deemed satisfaction rule. B, the debtor, is treated as having satisfied its $1 million debt for $980,000, which creates $20,000 of cancellation of debt income for B.

Simultaneously, S is treated as having sold the note for $980,000. Since S had a $1 million basis in the note, it realizes a $20,000 loss. The regulations then conform the character of B’s income and S’s loss, making S’s loss an ordinary loss that perfectly offsets B’s ordinary income on the consolidated tax return.