IRS considers replacing SRLY limitations with sec. 382-type approach.

• Author: White, George
• Position: Separate return limitation years; consolidated corporations; IRC section 382

For over 30 years, the consolidated return regulations have placed limits on the extent to which a consolidated group can use a new member's attributes (e.g., net operating loss carryovers from separate return years). These are termed separate return limitation years (SRLYs). The general thrust of the SRLY limitations is to prevent the group from reaping the principal benefit of filing consolidated returns--the ability to offset one member's loss against another member's income. Instead, the new member is treated as if it were still filing separate returns: It must generate its own income to absorb its loss carryovers. Otherwise, the consolidated return system would become a vehicle for "trafficking" in losses.

The Tax Reform Act of 1986 completely overhauled the Code's protection against loss trafficking, with enactment of "new" Sec. 382. Generally, new Sec. 382 bars an investor from achieving a greater benefit, through acquisition of a company with loss carryovers, than would be obtainable from an investment in tax-exempt securities. Sec. 382 operates by placing an annual limit on the absorption rate of loss carryovers, a limit that is a function of the value of the loss company's equity. The operation of Sec. 382 is triggered by a greater-than-50% shift in the ownership of a loss company occurring within a defined time frame (generally three years). Usually (but not always), a new member joins a consolidated group as a result of an ownership change large enough to trigger Sec. 382 (e.g., the group increases its ownership in the loss company from 0% to 80% (or more)). In this situation, the new member is subject to both SRLY and Sec. 382, and the more onerous of the two limitations controls.

Many commentators have expressed the view that the SRLY limitations are superfluous when both SRLY and Sec. 382 apply. In the interest of simplification, the AICPA Tax Division's Consolidated Tax Issues Task Force (CTITF) recommended in December 1996 that the SRLY limitations be dropped in the overlap situation. (In April 1998, the American Bar Association (ABA) Tax Section recommended that the SRLY limitations be retained.)

On Aug. 3, 1998, the IRS published Notice 98-38, stating its intention to consider replacing the SRLY limitations, across the board, with an approach modeled on Sec. 382. The Service expressed its concern over the complexity of the current regime, especially in the overlap situation, and invited comments on the proposal.

In August...