The IRS Office of Chief Counsel released Advice Memorandum 2012-010, which discusses how certain acquisition-related transaction costs should be allocated between short tax periods when a target corporation (the terms "target" or "subsidiary" are used interchangeably as the context requires) joins a consolidated group. The advice memorandum considers the following three deduction items: (1) The target's nonqualified stock options and stock appreciation rights (SARs) vest on the date of a change in control; (2) the target's financial advisory and investment banking fees incurred in connection with the acquisition become fixed and determinable on the date of a change in status; and (3) the target's debt is retired at a premium after closing on the acquisition date. To aid understanding of the guidance in the advice memorandum, this item briefly summarizes some of the relevant rules that govern the tax years of subsidiaries that join or leave a consolidated group.
Tax Year of Consolidated Group Members
As a general matter, Regs. Sec. 1.1502-76(b)(l)(i) provides that a consolidated group's tax return includes the common parent's items of income, gain, deduction, loss, and credit for the entire consolidated return year. However, the group's return includes a subsidiary member's items only for the portion of the year during which it is a member of the group. The subsidiary member's items that are not included in the group's return must be included in a separate return (including the consolidated return of another group). Specific rules govern the allocation of such items to avoid their duplication or elimination.
End-of-the-day rule and exceptions: Under Regs. Sec. 1.1502-76(b)(1)(ii)(A)(1), if a target becomes or ceases to be a member of a consolidated group during a tax year, its status as a group member begins or ends at the end of the day on which the change occurs. The target's tax year ends for all federal income tax purposes at the end of the change date. The regulations also require that appropriate adjustments be made, such as the restoration of intercompany transaction items or excess loss accounts.
Special rules apply when an S corporation becomes a member of a consolidated group. Under Regs. Sec. 1.1502-76(b)(1)(ii)(A)(2), except where the S corporation becomes a member through a qualified stock purchase with a Sec. 338(g) election in place, an S corporation becomes a member of the consolidated group at the beginning of the day that includes the acquisition, and its tax year...