Service rules attribute reduction under Sec. 108(b) on a consolidated basis.

Tax professionals should be aware of Field Service Advice (FSA) 9912007. It concludes that, if members of a consolidated group exclude discharge of indebtedness (COD) income under Sec. 108(a), the required attribute reduction under Sec. 108(b) must reduce the group's consolidated net operating loss (CNOL) as a tax attribute, even if no portion of the CNOL is attributable to the members with the excluded income.

The following example is provided in the FSA.

Example: P is the parent of B, which owns over 80% of C. P files a consolidated return that includes B, C and other group members. Several years before the year at issue, a number of substantial intercompany loans were made by P to B and, to a lesser extent, by B to C.

Thereafter, P, B and C joined in filing a Chapter 11 bankruptcy petition. A plan of reorganization was filed on behalf of the debtors and approved by the bankruptcy court. Under the plan, B and C merged into P. Additionally, the members' substantial intercompany debts were cancelled.

At issue is the taxpayer's treatment of the discharge of indebtedness from the plan of reorganization. Because B and C were discharged from their debts in a Title 11 case, they excluded their COD income under Sec. 108(a). They reduced only CNOLs attributable to B and C. B and C reduced their tax attributes for this amount in accordance with Sec. 108(b). Finally, P and B (i.e., the creditor members) claimed bad debt deductions for approximately the amount of discharge, which ultimately increased the group's CNOL carryforward by a like amount.

The taxpayer contends that the CNOL attributable to P and B (i.e., the group's creditor members) is not a tax attribute of B and C, respectively (i.e., the group's debtor members), and is not subject to Sec. 108(b) attribute reduction. Although there is not much authority on this subject, the taxpayer argued that the reference to tax attributes of "the taxpayer" in Secs. 108(b)(1) and 1017(a) clearly indicates that attribute reduction in a consolidated group is to be done on a member-by-member basis. In fact, the IRS had previously ruled on a Sec. 108(b) attribute reduction issue in Letter Ruling 9121017, using the same reasoning to arrive at the Conclusion that attribute reduction under Sec. 108(b) in a consolidated group is on a member-by-member basis. Of course, Letter Ruling 9121017 cannot be cited as precedent.

The FSA does not agree with this result. Although it acknowledges that each member of a consolidated group has separate taxpayer status, the FSA believes that attribute reduction, at least for CNOLs, should be for the entire CNOL. The FSA position is based on the premise that a tax attribute listed in Sec, 108(b) includes any amount that the debtor-taxpayer can use to reduce its future taxes. The FSA states that, because the CNOL, which is attributable to P (or B), is available to reduce B's and C's (as well as P's) future taxes, it should be subject to Sec. 108(b) attribute reduction. Because each member of the group is severally liable under Regs. Sec. 1.1502-6, a CNOL deduction reduces the tax liability of every group member, without regard to which member the CNOL was attributable. As a result, a CNOL is a tax attribute potentially usable by every consolidated group member.

Finally, the FSA, for the reasons stated above, refused to follow the reasoning of Letter Ruling 9121017, believing such reasoning to be "incorrect" (and, of course, not precedent). The FSA also noted various factual distinctions between Letter Ruling 9121017 and the FSA, which were not addressed in the memorandum. In addition, the IRS was clearly upset with the result of COD income not reducing the consolidated group's tax attributes, while the corresponding bad debt deduction actually increased the CNOL. This situation could not happen under current regulations; see Regs. Sec. 1.1502-13(g)(3)(ii)(B)(2).

Although the Service's argument may have merit for CNOLs, it is difficult to reconcile the FSA's position with Sec. 1017 when basis is the tax attribute. Sec. 1017(b)(3)(D) contains a special rule for depreciable basis reduction for affiliated groups. This rule, an election to treat subsidiary stock as depreciable property to the extent such subsidiary reduces its depreciable basis for a like amount, is meaningless under the FSA's rationale. Thus, it appears clear that attribute reduction, at least for basis reductions, should only be on property actually held by the debtor member.

What is the state of the law after this FSA? Clearly, neither a letter ruling nor an FSA is precedent. The only real authority is Secs. 108(b) and 1017, which clearly refer to the "taxpayer." Although the Service is unlikely to take this position when the attribute at issue is property basis (for the reason provided above), if the IRS wishes to pursue this position for CNOLs, it would appear to need at least some authority in the consolidated return regulations.

FROM STEVE BROWN, CPA, AND ED SAIR, J.D., MLT, CPA, WASHINGTON, DC