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Consolidated group’s NOL, not individual members’ NOLs, reduced by excluded COD income

Marvel Entertainment, LLC, (07/21/2015) 145 TC No. 2145 TC No. 2

The Tax Court has held that, where members of a consolidated group have cancellation of debt (COD) income that is excluded under Code Sec. 108, and the attribute that is reduced as a result of that exclusion is net operating loss (NOL), it is the consolidated group’s NOL, not the members’ NOLs, that is reduced.

Background. Code Sec. 61(a)(12) provides that gross income includes COD income. But Code Sec. 108(a)(1)(A) excludes from gross income any amount derived from “the discharge (in whole or in part) of indebtedness of the taxpayer” if the discharge occurs in a title 11 bankruptcy case. However, the price of exclusion is that certain of the taxpayer’s favorable tax attributes must be reduced to the extent of the excluded COD income. Code Sec. 108(b)(2)(A) provides that the first attribute that must be reduced is any net operating loss for the tax year of the discharge, and any net operating loss carryover to such tax year.

Facts. Several members of a consolidated group of corporations had ’98 COD income that was excluded because of their bankruptcies. The composition of the consolidated group changed thereafter. IRS and the taxpayers agreed that NOL should be reduced by the excluded income, but the parties disagreed as to whether the NOL that should be reduced was that of the consolidated group as a whole (CNOL) or whether that amount should have been allocated to the members. IRS argued that the CNOL should be reduced.

The consolidated NOL must be reduced. The Tax Court held for IRS, citing the Supreme Court’s holding in United Dominion Industries Inc., (S Ct 2001) 87 AFTR 2d 2001-237787 AFTR 2d 2001-2377, that a consolidated group member cannot have a separate NOL for a consolidated return year unless a specific consolidated return reg allocates and apportions part of the CNOL to that member. No such reg existed for taxpayer’s ’98 tax year, and therefore the proper NOL subject to reduction under Code Sec. 108(b)(2)(A) was the taxpayer’s CNOL.

The taxpayer also argued that the words “the taxpayer” in both Code Sec. 108(b)(1) and Code Sec. 108(b)(2) refer only to the debtor member of a consolidated group that has excluded COD income as a result of that member’s bankruptcy. The taxpayer therefore reasoned that “the tax attributes” subject to reduction under Code Sec. 108(b)(2)(A) cannot include the CNOL of the entire affiliated group because “the CNOL is not an attribute belonging to an individual member of a consolidated group, and thus cannot be what is reduced under Code Sec. 108(b).”

But the Court said that Code Sec. 108 is not clear in its intent with respect to the taxpayer’s argument. It then looked to the intent of Code Sec. 108 as a whole, which Congress said was to create a deferral, not a permanent exclusion, of the income being excluded. Taxpayer’s argument would have resulted in a permanent exclusion, while IRS’s argument would result in deferral, so the Court rejected taxpayer’s argument.

References: For excludable COD income, see FTC 2d/FIN ¶  J-7400  ; United States Tax Reporter ¶  1084.01  ; TaxDesk ¶  188,011  ; TG ¶  12931  .