Investment-adjustment regulations may significantly affect 1995 and later years' E & P determinations.

• Author: Blair, David W.
• Position: Earnings and profits

The final consolidated return regulations under the new investment-adjustment system (IAS) (new Regs. Sec.1.1502-32), effective for tax years beginning on or after Jan. 1, 1995, delink the determination of basis for subsidiaries in a consolidated group from the determinations of earnings and profits (E&P) (new Regs. Sec. 1.1502-33). For E&P determinations in consolidated return years beginning on or after Jan. 1, 1995, E&P generally must be determined or redetermined as if the new consolidated E&P principles were in effect for all years. While the impact on E&P calculations will vary considerably based on a consolidated group's particular history, the most significant impact will be felt by consolidated groups with the following characteristics:

* Groups with subsidiaries that generated net operating losses (NOLs) in consolidated return years that have not been used in consolidation (subsidiary NOL groups).

* Groups with histories that predate 1976 and/or 1996 (old consolidated groups).

* Groups with members that had separate return limitation year (SRLY) NOLs when they entered the group that were subsequently used in consolidation in tax years beginning before Jan. 1, 1995 (subsidiary SRLY NOL group).

The new E&P rules also make changes in the areas of deconsolidations of subsidiaries and group structure changes that generally apply prospectively. Changes to the rules for the allocation of Federal tax liability (in both the IAS and E&P determinations in a consolidated group context) give rise to a one-time opportunity to conform the E&P Federal tax allocation to that used for the IAS.

Affected taxpayers should address the significant changes in E&P calculations as soon as possible, particularly because, in some cases, considerable work and analysis will be necessary to cumulatively determine or redetermine E&P under the new rules. Also, information may be incomplete, unavailable or uneconomical to retrieve - a situation specifically noted in the regulations' preamble.

Summary of New E&P Rules

In the discussion below, P is the common parent and S (unless otherwise indicated) is a wholly owned subsidiary of P. The major changes in the new E&P rules may be summarized as follows:

* Separate tier-up system: E&P of subsidiaries tier up to the parent (from the lowest to the highest tier) under the IAS principles, except that the adjustment is by reference to E&P, not taxable income (e.g., the adjustment for S-generated consolidated return NOLS...