United Dominion: the Supreme Court enters the consolidated return fray.

• Author: Axelrod, Lawrence M.
• Position: United Dominion Industries v. United States - Consolidated tax returns

Earlier this summer, the Supreme Court of the United States issued its first opinion relating to the consolidated return provisions in 67 years. Although narrowly written, the Court's decision in United Dominion Industries v. United States, No. 00-157, 2001 U.S. LEXIS 4124 (June 4, 2001), is likely to be cited by taxpayers and the Internal Revenue Service for years to come.

The specific question before the Court in United Dominion concerned the 10-year carryback rules for product liability losses (PLLs). In an 8-1 opinion, the Court ruled that in a consolidated group, a PLL is calculated on a consolidated (single-entity) basis, not a member-by-member (separate-member) basis. The United Dominion decision may well have implications far beyond those PLL carryback rules.

Background

Section 172 of the Internal Revenue Code allows a corporate taxpayer to carry net operating losses (NOLs) backward or forward. During the years at issue, the general carryback period was three years, but section 172(b)(1)(I) provided a ten-year carryback for PLLs. A PLL was defined as the lesser of the taxpayer's NOL or its deductible product liability expenses (PLEs). Thus, a taxpayer with no NOL could have no PLL, even though the taxpayer incurred PLEs.

Under Treas. Reg. [sections] 1.1502-11, a group's consolidated taxable income (CTI) or consolidated NOL (CNOL) is computed by first adding together the separate taxable incomes (STIs) of each member. STI of a member -- including a case in which deductions exceed income -- is defined under Treas. Reg. [sections] 1.1502-12 as the member's taxable income computed in accordance with the Code, with certain adjustments. The adjustments eliminate items that are determined on a consolidated basis, and modify taxable income to take into account special consolidated return rules. The sum of the STIs is then combined with the items determined on a consolidated basis (e.g., capital gain net income, section 1231 net losses, charitable contribution deductions, dividends received deductions, and section 247 deductions) to compute CTI (or CNOL).

United Dominion was the parent of a consolidated group and reported CNOLs in excess of aggregate PLEs for the years 1983 through 1986. The five group members that generated a substantial portion of the PLEs, however, reported positive STI during each of those same years.

In tax refund claims, United Dominion asserted that it had PLLs for each of those years, calculated by comparing the group's total PLEs against the CNOL. The IRS disallowed the claim, contending that each member's PLE should be compared to that member's STI, determined under Treas. Reg. [sections] 1.1502-12. Since each member with PLEs had positive STI, the refund claims were denied.

The U.S. District Court for the Western District of North Carolina ruled in favor of the taxpayer, concluding that the group's CNOL -- including its product liability losses -- could be carried back to offset the group's earlier year consolidated taxable income. The Fourth Circuit reversed, agreeing with the IRS's conclusion that the single-entity approach of computing a consolidated group's...