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IRS Proposes "Next Day Rule" for Changes in Consolidated Group Membership.

(Parker Tax Publishing March 18, 2015)

The IRS has issued proposed amendments to the consolidated return regulations, revising the rules for reporting certain items of income and deduction that are reportable on the day a corporation joins or leaves a consolidated group. The proposed regulations would affect these corporations and the consolidated groups that they join or leave. REG-100400-14.

Background

The proposed regulations provide guidance under Reg. Sec. 1.1502-76, which prescribes rules for determining when items of income, gain, deduction, loss, and credit (tax items) of a corporation that joins in filing a consolidated return are included. Reg. Sec. 1.1502-76(b) provides, in part, that if a corporation becomes or ceases to be a member of a consolidated group during a consolidated return year, that corporation must include in the consolidated return its tax items for the period during which it is a member. The corporation also must file a separate return (including a consolidated return of another group) that includes its items for the period during which it is not a member.

Under the end of the day rule of Reg. Sec. 1.1502-76(b)(1)(ii)(A)(1) in the current regulations, a corporation is treated as becoming or ceasing to be a member of a consolidated group at the end of the day of the corporation's change in status, and the corporation's tax items that are reportable on that day generally are included in the tax return for the tax year that ends as a result of the corporation's change in status.

There are two exceptions to the current end of the day rule. The first exception, in Reg. Sec. 1.1502-76(b)(1)(ii)(A)(2) (S corporation exception), provides that if a corporation is an S corporation immediately before becoming a member of a consolidated group, the corporation becomes a member of the group at the beginning of the day the termination of its S corporation election is effective, and its tax year ends for all federal income tax purposes at the end of the preceding day.

The second exception, in Reg. Sec. 1.1502-76(b)(1)(ii)(B) (current next day rule), provides that if a transaction occurs on the day of the corporation's change in status that is properly allocable to the portion of the corporation's day after the event resulting in the change, the corporation and certain related persons must treat the transaction as occurring at the beginning of the following day for all federal income tax purposes.

Proposed Next Day Rule

The IRS has determined that changes should be made to Reg. Sec. 1.1502-76(b) due to uncertainty regarding the appropriate application of the current next day rule. To provide certainty, the proposed regulations clarify the period in which a corporation must report certain tax items by replacing the current next day rule with a new exception to the end of the day rule (proposed next day rule) that is more narrowly tailored to clearly reflect taxable income and prevent certain post-closing actions from adversely impacting the corporation's tax return. The proposed next day rule applies only to "extraordinary items" (as defined in Prop. Reg. Sec. 1.1502-76(b)(2)(ii)(C)) that result from transactions occurring on the day of the corporation's change in status, but after the event causing the change, and that would be taken into account by the corporation on that day.

The proposed next day rule requires those extraordinary items to be allocated to the corporation's tax return for the period beginning the next day. The proposed next day rule is expressly inapplicable to any extraordinary item that arises simultaneously with the event that causes the corporation's change in status.

The proposed regulations further clarify that fees for services rendered in connection with a corporation's change in status are an extraordinary item if they constitute a "compensation-related deduction." The proposed regulations also clarify that the anti-avoidance rule in Reg. Sec. 1.1502-76(b)(3) may apply to situations in which a person modifies an existing contract or other agreement in anticipation of a corporation's change in status.

The proposed regulations also add a rule (previous day rule) to clarify the application of the S-corporation exception. In addition, the proposed regulations limit the scope of the end of the day rule, the next day rule, the S corporation exception, and the previous day rule to determining the period in which a corporation must report certain tax items and determining the treatment of an asset or a tax item for purposes of Code Secs. 382(h) and 1374.

Additionally, the proposed regulations provide that short taxable years resulting from intercompany transactions to which Code Sec. 381(a) applies are not taken into account in determining the carryover period for a tax item of the distributor or transferor member in the intercompany Code Sec. 381 transaction or for purposes of Code Sec. 481(a). Furthermore, the proposed regulations provide that the due date for filing a corporation's separate return for the taxable year that ends as a result of the corporation becoming a member is not accelerated if the corporation ceases to exist in the same consolidated return year.

The proposed regulations make several other conforming and non-substantive changes to the current regulations, along with adding several examples to illustrate the proposed rules. The IRS notes that neither the current regulations nor the proposed regulations are intended to supersede general rules in the Code and regulations concerning whether an item is otherwise includible or deductible.

The proposed regulations are not effective until finalized.

For a discussion of consolidated income tax returns for corporations, see Parker Tax ¶42,120. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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