Good news in consolidated loss disallowance rules.

• Author: Gordon, Jared
• Position: Taxation

Consolidated groups that have sold member stock at a loss in the last decade or so know to expect little by way of good news from the loss disallowance rules (Regs. Sec. 1.1502-20). However, groups realizing loss on disposition of member stock should not overlook two potentially advantageous items. First, groups should take full advantage of a taxpayer-friendly netting rule when computing the amount of loss disallowed. Second, amounts properly disallowed on such sales still reduce the group's earnings and profits (E&P), benefiting the parent's shareholders by decreasing the amount of any distributions characterized as dividends under Sec. 316.

Cessation of Netting Rule

One of the principal disadvantages of electing to file a consolidated return is the potential disallowance of some (or all) of the loss realized on disposition of member stock. The amount of loss disallowed equals the sum of (1) positive investment adjustments (PIAs) allocable to the member stock that was sold, (2) a subsidiary's "extraordinary gain dispositions" and (3) its "duplicated loss."

PIAs are not precisely the same as the net adjustments to the member's stock. For instance, PIAs exclude basis decreases attributable to distributions and basis increases attributable to capital contributions and are subject to certain restrictions. One of those restrictions (the netting rule) can significantly reduce the amount of loss disallowed, thus increasing the amount of allowable loss.

When computing PIAs, a net negative adjustment (under Regs. Sec. 1.1502-32) from one year generally cannot offset another year's net PIA. However, the regulations provide a transition rule that expressly permits such netting during certain years. Indeed, this rule permits groups to apply netting in a way that produces the maximum allowable loss.

The loss disallowance resulting from PIAs during the netting period is limited to the aggregate increase (if any) in the basis of the subsidiary stock during the period, beginning on the date the subsidiary was acquired and ending on the close of any tax year ending on or before Sept. 13, 1991. (For tax years beginning after that date, a group must include all PIAs in the loss disallowance calculation, ignoring years in which there was a net basis decrease.) During this transition period, a group may select the netting period that results in the lowest PIA for the transition period beginning on the date the subsidiary was acquired and ending on the close...