Consolidated Tax Reporting's Increasing Importanceby
Tax planners need to periodically review with clients whether to incorporate and when to consider multiple corporations. Mike Pusey, CPA explores the details of consolidated returns and why tax pros may need to consider them for their clients more than in the past.
It has become increasingly important to advise clients of the consolidated reporting option that may be available with multiple corporations (See Section 1501, and the author’s article “Dealing with Consolidated Returns for the Midsized,” in this publication, July 22, 2020).
The Proliferation of Entities
Incorporating is an avenue to sheltering from loss. It can limit slip-and-fall and other law suit losses to the assets in one entity. Lawsuit exposure may be limited to the assets in a corporation. Maximizing asset protection can often result in more and more entities.
Limited liability companies, when owned by one individual (one-member LLCs), may be disregarded. This is one avenue to achieving loss protection.
An LLC may also elect to be taxed as a corporation. It would generally be possible for an LLC to function within a consolidated reporting context although the topic is generally beyond our scope. Incorporating in different taxing jurisdictions can contribute to the proliferation of entities.
Corporate income is subject to a federal tax rate of 21 percent, whereas there are seven individual tax rate brackets.
- the first two individual brackets are lower than the corporate rate brackets
- brackets three and four are close to the 21 percent
- brackets five through seven are notably higher than the corporate rate
The ranges of income subject to the different rates vary significantly depending on the individual’s marital status. An added complexity is the possibility of tax rate changes for individuals and corporations.
The C corporation structure has a double-taxation problem due to the taxability of dividends. Also, the C corporation doesn’t have the benefit of the 20 percent of business income deduction. For many, the C corporation may present the possibility of shifting income to a lesser tax rate, which can be particularly important when the goal emphasizes growth.
The Corporate Filing Options
The same individual or family member, as well as unrelated parties, is apt to have direct ownership in multiple entities. The typical brother-sister group of corporations may elect Subchapter S. The consolidated reporting approach requires more direct corporate ownership.
A consolidated return is filed on the familiar Form 1120. There are elections and consent (See Form 851, Affiliation Schedule, and Form 1122, Authorization and Consent of Subsidiary Corporation to Be Included in a Consolidated Tax Return; Regs. 1.1502-75). When the tax professional finds multiple C corporations, the consolidated reporting option needs to be carefully considered.
To file a consolidated return, the parent company must own at least 80 percent of the voting power and value of the stock of at least one other member of the group (See Sec. 1504). The key is interrelated corporate ownership. For example, the following U.S. corporations could file consolidated returns:
- The parent, A, owns 80 percent of B that owns 100 percent of C
- The parent, A, owns 100 percent of B, 100 percent of C, 100 percent of D
Our discussion doesn’t encompass direct or indirect ownership of foreign corporations and the concept of controller foreign corporations (“New Tax Law May Result in Additional Taxes for Certain US Persons Who Directly or Indirectly Own Equity in a Foreign Corporation,” Drier & Weeks, White & Case, 3/18/2018; whitecase.com).
Also keep in mind the need the state filing implications.Our scope doesn’t reach the rules that may govern financial reporting.
Why File Consolidated Tax Returns?
Before 2017, corporate NOLs could be carried back two years. In 2017, the Tax Cuts and Jobs Act (TCJA) started disallowing loss carrybacks and limiting NOL deductions generally to 80 percent of taxable income. In 2020, the CARES Act allowed NOLs from a tax year beginning in 2018, 2019 and 2020 to be carried back five years.
It is possible to waive the loss carryback and carry NOLs to future years. The five-year carryback relief could also access tax years in which the corporate rate exceeded the current 21 percent rate. The five-year carryback privilege doesn’t apply to 2021, the 80 percent limitation basically applies to tax years beginning after 2020.
It may be simpler and advantageous to have losses of one corporation offset income of profitable members in a consolidated return. This is usually the primary advantage for filing consolidated returns. In our new environment of legislative restrictions on loss carrybacks, the advantages of consolidated filing are increasingly important.
Consolidated returns can enable the offsetting of operating profits and losses within the group. They can also enable capital losses to offset capital gains elsewhere within the group, subject to the limitation on pre-acquisition losses (Sec. 384). Electing consolidated reporting will bring into play consolidated reporting of credits.
There can be loss limitation rules to consider. Pre-consolidation losses may be limited under the separate-return-limitation-year (SRLY) rules and Section 382 (See “Considering the SRLY rules and Sec. 382 in the post-TCJA World,” Heath Wang, The Tax Adviser, AICPA, May 1, 2019; see also Regs. 1.1502-21). Section 382 deals with NOL use limitations following an ownership change, and there can be added complexities with this rule in a consolidated return environment (See Regs. 1.382-6(b); PLR 202142007, PLR 202142008).
Another possible advantage to consolidated reporting is deferring gains on sales within the group (Regs. 1.1502-13; see also PLR 201722012, 6/2/17 involving gain exclusion). There are also stock basis adjustment rules for subsidiaries owned by another member (Regs. 1.1502-32).
Various code provisions may apply in addition to the rules detailed in the consolidated return regulations (See Regs. 1.1502-13(a)(4) citing Sections 267(f), 269 and 482). So the tax practitioner may encounter the usual complexities plus new ones in the consolidated return regulations.
A practitioner unfamiliar with the consolidated tax reporting may want to study via a continuing education course or other avenue. However, it can be important that the practitioner even encourage the client’s choice of consolidated reporting when circumstances warrant.
Consolidated filing is an important consideration, particularly when losses cannot be carried back. Moreover, it is important to understand the potential benefits and reasons for consolidated reporting in our current environment of limited loss carrybacks, particularly the ability of such reporting to use losses against the income of related corporations. Of course, the client’s particular circumstances need to be reviewed prior to electing consolidated reporting.
Mike Pusey, CPA served as National Tax Director at Rojas & Associates. He has a BBA and Master of Science in Accounting from Texas Tech where he graduated with honors. He planned to be an accounting professor and worked a year on the Ph. D. at the University of Arizona before beginning his career at KPMG Peat Marwick, where he worked in...