Applying attribute reduction under Sec. 108(b) in a consolidated group.

• Author: Sair, Edward A.

In United Dominion Industries, Inc., 532 US 822 (2001), rev'g 208 F3d 452 (4th Cir. 2000), the Supreme Court held that in a consolidated group, a product liability loss (PLL) is calculated on a consolidated (single-entity) basis, not a separate-member (member-by-member) basis, as the government argued. Although the taxpayers prevailed, the Court's adoption of that approach may have implications for other issues facing consolidated groups, such as the Sec. 108(b) attribute reduction that results from the exclusion of cancellation of debt (COD) income when a member is insolvent or in bankruptcy. Specifically, in determining a group member's attributes to be reduced, the issue becomes whether the member-by-member or the single-entity approach applies.

Background

Sec. 108(b) attribute reduction. Sec. 61(a)(12) ordinarily requires a taxpayer to include COD income in gross income. However, Sec. 108(a) excludes COD income to the extent of an insolvency (if applicable), or entirely when the discharge occurs in a Title 11 case (i.e., pursuant to a bankruptcy plan). However, under Sec. 108(b), the taxpayer must then reduce its tax attributes (e.g., loss carryovers, credits and property basis) to the extent of the exclusion.

Tax attributes are reduced under Sec. 108(b) to the extent of the debt discharge excluded from income under Sec. 108(a)(1); taxable income generally -s not created if that amount exceeds the taxpayer's attributes available for reduction; see S. Rep't No. 96-1035, 96th Cong., 2d Sess. 14 (1980) ("Senate Report"). Stated differently, once all the attributes are reduced, no further action is required; the remaining amount of excluded debt discharge is disregarded. However, if the excluded COD exceeds a subsidiary's attributes, and the owning member has an excess loss account (ELA) as to the subsidiary's stock, the member must include the ELA in income under Regs. Sec. 1.1502-19(c)(1)(iii)(B).

Under Sec. 108(b)(2), a taxpayer's tax attributes are reduced in the following order:

1. Net operating losses (NOLs);

2. General business credits;

3. Minimum tax credits;

4. Capital-loss carryovers;

5. Property basis;

6. Passive activity loss and credit carry-overs; and

7. Foreign tax credit carryovers.

   A taxpayer may elect under Sec. 108(b)(5) to reduce the basis of depreciable assets before reducing other attributes. Additional rules for asset-basis reductions are provided in Sec. 1017.

   United Dominion. The Supreme Court held in United Dominion that a consolidated group's 10-year carryback of PLLs is computed on a single-entity basis, not by segregating such losses on a company-by-company, separate-member basis. It found there was no definition of a separate NOL for a member of an affiliated group and rejected the Fourth Circuit's attempt to apply the apportionment rules under former Regs. Sec. 1.1502-79(a) (3) (the predecessor to Regs. Sec. 1.1502-21(b)(2)(iv)), in determining one. In describing the inapplicability of the apportionment rules, the Court stated, "Section 1.1502-79(a) (3) unbakes the cake for only one reason, and that reason has no application here. "Actually, as is discussed later, the apportionment rules slice the cake for reasons that did not apply in United Dominion.

   Although the Court correctly determined that the apportionment rules did not apply, it was an overstatement to maintain that they exist for only one-reason. For example, apportionment is necessary to determine a subsidiary's share of a consolidated NOL (CNOL) for stock-basis-adjustment purposes; see Regs. Sec. 1.1502-32. The allocation is based on the CNOL multiplied by a fraction, the numerator of which is the separate NOL of such corporation; the denominator is the sum of the separate NOLs of all group members with losses; see Regs. Sec. 1.1502-21.When considering carrybacks and carryovers, the apportionment rules apply only if the loss would be carried over to a separate return year, a condition not present in United Dominion.

   United Dominion's effect. The appropriate use of the apportionment rules is significant to the application of Sec. 108 to consolidated groups. Although the amount of a group's CNOL...