Proposed regulations would provide guidance for allocation and absorption of losses on a consolidated return.

• Author: DuPree, Duane

Under rules for consolidated returns, the consolidated net operating loss (NOL) or consolidated taxable income is the sum of each entity's separate taxable income or loss calculated under Regs. Sec. 1.1502-12 and certain items of income and deduction computed on a consolidated basis under Regs. Sec. 1.1502-11. Proposed regulations issued in June (Prop. Regs. Sec. 1.1502-21, REG-101652-10) address an issue when there is a consolidated NOL.

Under current consolidated NOL rules, Regs. Sec. 1.1502-21(b)(2)(i) states that when a group has a consolidated NOL and that NOL is attributable to a member and can be carried to a separate return year, the amount of the consolidated NOL that is attributable to the member is apportioned and carried to the separate return year. The apportioned amount of the consolidated NOL attributable to a member is determined under Regs. Sec. 1.1502-21(b) (2) (iv).

The apportioned amount is calculated by multiplying the consolidated NOL by the separate NOL of the member for the consolidated return year divided by the sum of the separate NOLs of all members having such losses. The separate NOL of a member is determined by computing the consolidated NOL by reference to only that member's items of income, gain, deduction, and loss. However, the current regulations do not expressly adopt this same fraction-based method for computing the amount of each member's absorbed loss that is used to offset the income of members with positive separate taxable income or net capital gain for the consolidated return year in which the loss is recognized.

The apportionment method in Regs. Sec. 1.1502-21(b)(2)(iv) generally produces appropriate results; however, an issue may develop when one or more of the entities has a capital gain.

Example 1. Current law without capital gains: Company A, the parent, acquires Company B, the subsidiary. Company A and Company B file a consolidated return for the tax year ending after the acquisition. For the consolidated year, Company A generates a $100 loss, and Company B generates a $200 loss. Thus, the consolidated group has a $300 consolidated loss.

The amount of the consolidated NOL attributable to each member is determined taking into account only its items; therefore, Company A is allocated a $100 loss (the consolidated NOL of $300 x [the separate NOL of $100 / $300]). Company B is allocated a $200 loss (the consolidated NOL of $300 x [the separate NOL of $200 / $300]).

Example 2. Current law with...