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Tax Court Upholds IRS Allocation of NOL Among Members of Consolidated Group

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Four members of Marvel Entertainment Consolidated Group had Cancellation of Indebtedness (“COD”) income totaling $171,000,000 under IRC Section 108.  The Taxpayer took the separate entity approach in reducing the group’s net operating loss carryforward by the amount of COD income.  The Taxpayer first allocated to the four members their share of the consolidated non-operating loss carryforward.  One of the corporations was allocated approximately $82,000,000 of the consolidated net operating loss carryforward but it had $164,000,000 of COD income.  The Taxpayer reduced the $82,000,000 net operating loss carryforward to zero but the excess $82,000,000 of COD income in effect disappeared.  The IRS said that the $171,000,000 COD income had to be applied to the entire group’s consolidated net operating loss carryforward and not just to the share allocated to the four entities.  This reduced the consolidated net operating loss carryforward by $82,000,000.  The difference between the two approaches was approximately $16,500,000 in taxes.

The sole issue was whether the net operating loss subject to reduction under IRC Section 108 is the entire consolidated net operating loss of the consolidated group (single-entity) or a portion of a consolidated group’s consolidated net operating loss allocated to each group member (separate-entity).  The Tax Court, citing the Supreme Court in the United Dominion Industries, Inc. v. The United States, held that a consolidated group member cannot have a separate NOL for a consolidated return year unless a specific consolidated return regulation allocates a portion of the consolidated and operating losses to that member.  The Court noted that no such regulation existed for the Taxpayer’s year in question.  Accordingly, the Tax Court entered summary judgment in favor of the Internal Revenue Service.

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