Consolidated Tax Return: Filing Process, Pros, and Cons

Understanding a Consolidated Tax Return

A consolidated tax return is a corporate income tax return for an affiliated group of corporations that elects to report their combined tax liability on a single return. This allows corporations with multiple affiliates to be seen as one entity. Consolidated items include capital gains, net losses, and deductions like charitable contributions or net operating losses.

Key Takeaways

• A consolidated tax return allows affiliated entities to report taxes jointly.
• This benefits corporations operating through multiple entities.
• Consolidated items include capital gains, net losses, and certain deductions.
• IRS rules define how affiliate companies may consolidate and file.
• Companies ineligible to consolidate include certain insurance companies, foreign corporations, tax-exempt corporations, regulated investment companies, real estate investment trusts, and S corporations.

Election to File a Consolidated Tax Return

Each affiliated corporation must consent to file a consolidated tax return by submitting Form 1122 with Form 1120. Afterward, new members must join the consolidated return.

An affiliated group is defined as "one or more chains of includible corporations, connected through stock ownership, with a common parent corporation." The parent corporation must own 80% or more of the voting power and value of the stock in at least one of the other includible corporations.

Corporations in the group must also have their voting power and stock value 80% owned by one or more other corporations.

Form 851 and supporting documentation for each entity must be attached to Form 1120.

Filing Process of a Consolidated Tax Return

The parent company files the consolidated tax return, and subsidiaries must align their tax year with the parent company’s tax year. [Clay: Please explain ". align their tax year with the parent company’s tax year." Is it mentioned in the citation?/jc] Affiliates must provide their own tax information, such as taxable income and deductions.

Affiliates must also determine any transactions between companies, like lending or renting property or buying and selling goods or services. Each affiliate reports its net income or loss, disregarding consolidated items, to determine separate taxable income.

The consolidated taxable income is calculated by summing the separate taxable incomes of all affiliates and netting the consolidated items.

Advantages and Disadvantages of a Consolidated Tax Return

Advantages

A consolidated tax return can significantly adjust the combined tax liability of an affiliated group. For example, it eliminates tax on sales between connected corporations and defers taxable gains or losses until sold to an outside third party.

One affiliated corporation’s income can offset another’s losses. Capital gains and losses can be netted across affiliates, and foreign tax credits can be shared.

Disadvantages

Calculating the accumulated earnings tax includes the profits and losses of all affiliates, allowing only a single minimum credit amount. Intercompany income and losses are deferred.

The impact of filing a consolidated return on each member and the affiliated group should be carefully considered, including eligibility, overall tax liability compared to separate filings, and the future effect of the election.

Tax Consolidation: Definition and Eligibility

Tax consolidation treats a group of affiliated companies, a parent company and its subsidiaries, as a single entity for tax purposes. In the U.S., this is permitted under Section 1501 of the Internal Revenue Code.

Inclusion of Foreign Incorporated Subsidiaries

Foreign affiliates cannot be included in U.S. group taxation except for certain Mexican and Canadian incorporated entities, foreign insurance companies electing domestic corporation treatment, and "expatriated" foreign corporations under "anti-inversion" rules.

Required Forms

The group of companies must file Form 1120, Form 851, and supporting documentation if requested.

The Bottom Line

Section 1501 of the Internal Revenue Code allows companies to report the taxable income of their qualifying subsidiaries and affiliates on a single return. Joint tax returns present corporations with multiple entities as one entity. However, they can be complex, difficult to terminate, and not suitable for everyone.