Federal Circuit invalidates duplicated-loss factor of loss-disallowance Regs.

• Author: Sair, Edward A.
• Position: Consolidated tax returns - Affiliated corporations

In Rite Aid Corp., 255 F3d 1357 (2001), the Federal Circuit ruled invalid the duplicated-loss factor of the loss-disallowance regulations under Regs. Sec. 1.1502-20(c)(1)(iii) and (c)(2)(vi). This factor, which purportedly sought to ensure that a parent and its subsidiary did not both benefit from a loss in the value of the subsidiary's assets, failed to reflect the consolidated group's tax liability and, therefore, was not within Treasury's authority under Sec. 1502.

Loss-Disallowance Regulations

Sec. 1501 allows affiliated corporations to file consolidated returns. By making a consolidated return, the consolidated corporations are deemed to have consented to all the regulations prescribed under Sec. 1502. One such regulation is Regs. Sec. 1.1502-20 (the loss-disallowance regulation), which disallows a loss on the sale of a subsidiary's stock to the extent the loss does not exceed the sum of (1) extraordinary-gain dispositions, (2) positive investment adjustments and (3) duplicated losses.

Extraordinary-gain dispositions disallow any loss on the sale of a subsidiary's stock to the extent that the subsidiary, while a member of the group, recognized income or gain (which causes a positive stock-basis adjustment) on certain clearly identifiable transactions occurring after Nov. 18, 1990. These transactions include (1) gain on the disposition of certain assets described in Secs. 1221, 1231 and 1060; (2) positive Sec. 481(a) adjustments; (3) discharge of debt income (to the extent it gives rise to a positive stock-basis adjustment); and (4) any other event (or item) identified in guidance published in the Internal Revenue Bulletin. The amount of any recognized income or gain is reduced by the expenditures directly related to the extraordinary-gain disposition, including allocable Federal income taxes. The extraordinary-gain-disposition factor applies even to assets the subsidiary acquired after joining the group.

Positive investment adjustments disallow any loss on the disposition of a subsidiary's stock, to the extent stock basis increased by positive earnings in any given year. Positive investment adjustments are defined as the sum of modified taxable income (as defined in Regs. Sec. 1.1502-32(b)(2)), not including distributions and taking into account only years in which the amount is positive. Thus, negative adjustments to stock basis during loss years are disregarded in computing the positive investment adjustment. To avoid double...