Corporations that become, cease to be members of consolidated group

Proposed Regulations: Corporations, consolidated group

The Treasury Department and IRS today released for publication in the Federal Register proposed regulations (REG-100400-14) to revise the consolidated return regulations and specifically 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 “one day” rule

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Read the proposed regulations [PDF 223 KB]


The proposed regulations concern a corporation (identified as “S”) that becomes or ceases to be a member of a consolidated group during a consolidated return year.

Regulations issued in 1966 were silent regarding the treatment of S’s tax items that accrued on the day that S became or ceased to be a member of a consolidated group. This was addressed when regulations were issued in 1994.

The 1994 regulations provide that S is treated as becoming (or ceasing to be) a member of a consolidated group at the end of the day of S’s change in status. Thus, the 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 S’s change in status.

Two exceptions applied to the end-of-day rule:

  • If a corporation is an S corporation immediately before becoming a member of the group, the corporation becomes a member of the group at the beginning of the day when its S corporation election terminates, and its tax year ends at the end of the preceding day.
  • If a transaction occurs on the day of S’s change in status, then S and certain related persons must treat the transaction as occurring at the beginning of the following day—referred to as the “current next day” rule.

Proposed regulations

Today’s changes are being proposed to address uncertainty regarding application of the current next day rule.

As explained in the preamble, the proposed regulations clarify the period in which S must report certain tax items by replacing the current next day rule with a new exception to the end of the day rule—the “proposed next day rule.”

The proposed next day rule:

  • Is tailored so that taxable income is clearly reflected
  • Is intended to prevent certain post-closing actions from affecting S’s tax return for the period ending on the day of S’s change in status
  • Applies only to “extraordinary items” that result from transactions that occur on the day of S’s change in status but after the event causing the change and that would be taken into account by S on that day
  • Requires the extraordinary items to be allocation to S’s tax return for the period beginning the next day
  • Is expressly not applicable to any extraordinary item that arises simultaneously with the event that causes S’s change in status

The proposed regulations clarify that: (1) fees for services rendered in connect with S’s change in status constitute a “compensation-related deduction” and are therefore an extraordinary item; and (2) the anti-avoidance rule of Reg. section 1.1502-76(b)(3) may apply to situations when a person modifies an existing contract or other agreement in anticipation of S’s change in status.

Also, a “previous day rule” is added to clarify the application of the S corporation exception.

The proposed regulations limit the scope of the end of the day rule, the next day rule, the S corporation exception, the previous day rule for determining the period in which S must report certain tax items and for determining the treatment of an asset or a tax item for purposes of sections 382(h) and 1374.The proposed regulations:

  • Provide that short tax years resulting from intercompany transactions to which section 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 section 381 transaction or for purposes of section 481(a)
  • Provide that the due date for filing S’s separate return for the tax year that ends as a result of S becoming a member is not accelerated if S ceases to exist in the same consolidated tax year
  • Make several conforming changes to current regulations
  • Add examples to illustrate the proposed rules

KPMG observation

Tax professionals have observed that the proposed regulations provide more certainty on several controversial issues—which would reduce uncertainty and disputes. As noted in the preamble, the IRS and Treasury found that taxpayers have “inappropriately interpreted” the existing regulations to afford electivity. However, it has been observed that the characterization that electivity is an inappropriate interpretation appears to be at odds with the plain language of the specific rule in the existing regulations that states that positions will be respected if “reasonable and consistently applied.”

Regardless, today’s proposed regulations provide for no electivity with respect to income and deduction items that arise simultaneously with the change of status, which would always be allocated to the pre-change in status return under the proposal. This treatment was a most disputed item under the existing regulations, and is consistent with the position the IRS has recently taken under current law.

The proposed regulations attempt to coordinate certain section 382 results with the new regime, but more work will be required to resolve items such as cancellation of indebtedness income that is realized on the change date.

Also, another important clarification in the proposed regulations is that the end of day rule applies only for limited purposes of allocating income and deduction items, and for certain aspects of section 382 and section 1374. Thus, a subsidiary will now be deemed to enter or leave the group for other purposes at the actual time the transaction occurs. The most surprising repercussion from that clarification is that transactions between a parent and subsidiary that cause the subsidiary to leave the group (such as a redemption of stock from the parent) will not be eligible for treatment as an intercompany transaction.

The proposed regime also adds an interesting corollary to the next day rule. Given that S corporations are deemed to join a consolidated group at the beginning of the day in which their status changes, certain items of income and deduction can now be moved back a day under a new “previous day rule.”


For more information, contact a tax professional with KPMG’s Washington National Tax:

Mark Hoffenberg | +1 (202) 533 4058 |

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