Timing of deductions for subsidiaries joining a new consolidated return.

• Author: Schwartzman, Randy A.

Under the consolidated return rules, special considerations apply when a subsidiary member (Sub) joins or leaves a consolidated group during the tax year. A consolidated return includes the parent's items of income, gain, deduction, loss, and credit for the entire consolidated return year, and each of Sub's items for the part of the year it was a group member. The part of Sub's income that is not included in the consolidated return is included in a separate return (including the consolidated return of another group).

To provide greater certainty and prevent inconsistent allocations, the original tax year of a subsidiary that joins or leaves the group during the year will be treated for all federal income tax purposes as ending as of the close of the day it becomes or ceases to be a member of a consolidated group (Regs. Sec. 1.1502-76(b)(1)). Absent an election to the contrary, income or loss is allocated on the basis of an actual closing of the books as of the end of its short tax year (Regs. Sec. 1.1502-76(b) (2)). However, inasmuch as a midyear closing can be burdensome, the regulations allow an election under which Sub could ratably allocate items of income, gain, deduction, loss, and credit (Regs. Sec. 1.1502-76(b)(2)(ii)(D)(1)).

Ratable Allocation

Regs. Sec. 1.1502-76(b)(2)(ii)(D)(1) requires the election to ratably allocate items be made on a separate statement and filed with the returns including the items for the years ending and beginning with Sub's status change.

Regs. Sec. 1.1502-76(b)(2)(iii) provides an alternate allocation approach that can be applied if a ratable allocation is not elected. This provision allows a ratable allocation of Sub's items in the month of its status change but generally requires an actual closing of the books as of the end of the previous month and the end of the month in which the change occurred.

End-of-the-Day Rule

If Sub becomes or ceases to be a member during a consolidated return year, it becomes or ceases to be a member at the end of the day on which its status as a member changes, and its tax year ends for all federal income tax purposes at the end of that day (Regs. Sec. 1.1502-76(b)(1)(ii)(A)(1)).

Next-Day Rule

If, on the day of Sub's change in status as a member, a transaction occurs that is properly allocable to the portion of Sub's income after the event resulting in the change, Sub must treat the transaction for all federal tax purposes as occurring at the beginning of the following day. A determination of whether a transaction is properly allocable to the portion of the day after the event, or the next day, is respected if it is reasonable and consistently applied to similar items (Regs. Sec. 1.1502-76(b)(1)(ii)(B)).

Extraordinary Items

Certain "extraordinary items" cannot be prorated and must be allocated to the day they are taken into account (Regs. Sec. 1,1502-76(b)(2)(ii)(B)(1 )). Extraordinary items include, among others, (1) items, from the disposition...