Final consolidated rules provide some relief from trap for the unwary.

In the January 1994 Tax Clinic column, we reported that proposed consolidated return regulations would require a downward adjustment to the basis of stock in lower-tier subsidiaries on the expiration of a purchased subsidiary's loss carryover. This could create an excess loss account which could then be triggered into income. See the Tax Clinic, "Proposed Consolidated Regulations Pose Trap for Unwary," TTA (Jan. 1994), at 19.

Unfortunately, the final regulations, published in August 1994, retain this provision, although expiring losses of group members acquired in consolidated return years beginning before 1995 are grandfathered and therefore will not be subject to a downward basis adjustment (Regs. Sec. 1.1502-32(b)(3)(iii) and (h)(4)). For expiring losses not grandfathered, some relief has been included. To the extent the purchased subsidiary has a loss carryover from a separate return limitation year, the group may make an irrevocable election to waive all or a part of such loss to the purchasing member as a result of the expiration of the loss carryover (Regs. Sec. 1.1502-32(b)(4)).

The waiver procedure is only fully effective when the loss company is directly acquired by purchase (defined as a cost-basis transaction in which basis is determined under Sec. 1012) during a 12-month period of an amount of stock satisfying the affiliation requirements of Sec. 1504(a)(2). If the loss subsidiary is acquired in a different manner (e.g., in a "B" reorganization), a waiver will nevertheless cause a downward adjustment to the acquiring corporation's stock for the waived losses, but such adjustment will not tier up to cause further negative adjustments to the stock of a higher-tier company. In addition, a waiver will not prevent the waived losses of a lower-tier member of an acquired chain of corporations from reducing the basis of the stock in each of the higher-tier members of such acquired chain of companies. The regulations in both these cases permit the downward basis adjustment to be limited to an amount that will reduce the basis in the member's stock to its net asset basis.

The waiver must be made in the first consolidated return that includes the loss member (per Regs. Sec. 1.1502-32(b)(4)(iv)). Since the general rule of the regulations presumes that acquirers pay $1 for each $1 of acquired losses, notwithstanding the maximum 35% marginal tax rate and potential limitations on the use of such losses under Sec. 382, etc., the substantive downward adjustment rule should be considered along with the waiver procedure in connection with the acquisition of a loss company in a consolidated return year beginning after 1994.