M&A Perspective: Who should be filing that return, and when?

Failure to understand the transaction steps and organizational structure in M&A transactions may cause companies to make costly and time-consuming mistakes in attempting to file an initial consolidated return. Buyers often create an acquisition structure made up of several tiers of domestic holding corporations to acquire a target corporation (Target) and its affiliates (Target Group).¹ This is common in private equity fund transactions. In order to determine the return filing impact of these transactions, companies must understand the following:

• Has the Target Group terminated and joined a new affiliated group (Parent Group)?
• If the Target Group has terminated, what must be done to file a consolidated return for the new Parent Group?
  
• If Parent Group does not make a valid and timely election to file a consolidated return, how does this affect the due date for Target Group’s short period return?
  

Significantly, a new Parent Group must make a valid and timely election to file a consolidated return.²  To do so, companies must understand the transaction steps and correctly identify the parent of the new group. If the election is invalid and/or untimely, then the taxpayer may need to seek relief to make a late election via a request for a letter ruling from the IRS under Reg. section 301.9100-3. This time-consuming process entails submitting affidavits, explaining the circumstances surrounding the missed election, and paying a costly letter ruling fee.

To file a consolidated return, an affiliated group must make a valid and timely election in the manner set forth in the Code and regulations. Primarily, a group makes a valid election through the filing of a consolidated return. Each subsidiary that is a member of the group during this initial year must give its consent by executing and filing a Form 1122 (“Authorization and Consent of Subsidiary Corporation to be Included in a Consolidated Income Tax Return”) accompanying the return. To make a timely election, the group must file the consolidated return no later than the last day prescribed by law (including extensions of time) for the filing of the common parent’s return.³ An election to file a consolidated return is made only for the first year a group chooses to file a consolidated return.

Significantly, a valid and timely election is not made if a taxpayer attempts to file its initial consolidated tax return but names the wrong entity as the common parent of the group. As discussed below, failing to identify the common parent of a new Parent Group is a common foot fault in certain M&A transactions.

Where Target’s shareholders do not receive the requisite amount of stock in Parent to be considered a reverse acquisition, then the Target Group terminates and joins the new Parent Group. Consider a situation where the buyer (or its advisors) do not properly identify or acknowledge the new common parent of Target and its affiliates, and the Target Group terminates as a result of the transaction.

Example 1. Parent is incorporated and forms Holding Inc. (Holding), its wholly owned subsidiary, on April 30, 2021. On the same day, Holding purchases all of the stock of Target solely for cash. The taxpayer files a consolidated return for the year ended Dec. 31, 2021 with Target listed as the parent of the group. The filing did not include Parent or Holding, and no separate returns were filed for either of these entities. All parties are calendar year taxpayers.

This transaction is not a reverse acquisition (see below). Therefore, the Target Group terminates and joins the new Parent Group. In order to have a valid consolidated return including Parent and the Target Group, the taxpayer must affirmatively make an election to file an initial consolidated return with Parent as the new common parent for the 2021 tax year. However, it was not until 2023 that the taxpayer and its advisors discovered that Parent should have been the common parent of the new Parent Group. The due date for the Parent Group to make a valid and timely election was April 15, 2022 (or Oct. 15, 2022, had proper extensions been made). In this case, the taxpayer filed an initial consolidated return with Target—and not Parent—as the common parent of the group. Thus, Parent Group did not make a valid and timely election to file a consolidated return, because a subsidiary of the new affiliated group, instead of Parent, filed a return with the intended election. Parent Group’s only option to file an initial consolidated return for 2021 (i.e., for Parent Group, with Parent as the common parent) is to seek relief to make a late election under Reg. section 301.9100-3.

Notably, the failure to make a proper election for Parent Group also affects the due date for Target Group’s final, short period return from Jan. 1, 2021 to April 30, 2021. Had Parent Group made a valid election to file a consolidated return, Target Group would not be required to file its short period return until the due date of Parent Group’s return for 2022, which is April 15, 2022 (or Oct. 15, 2022, with extensions). Without Parent Group filing as a consolidated group, however, Target Group’s due date (without extensions) for the short period is Aug. 15, 2021.⁴

Example 2. Same facts as Example 1, except that an extension of the deadline to file is made for Target, but not Parent. This issue is discovered prior to Oct. 15, 2022 (i.e., the would-be extended filing deadline for Parent) but after April 15, 2022.

Because a valid extension of time to file was not made for Parent, the due date to make an election to file an initial consolidated return for Parent Group is April 15, 2022. Even in this situation—i.e., where the issue is identified prior to Oct. 15, 2022—the taxpayer would need to seek relief under Reg. section 301.9100-3 for Parent Group to make a late election to file consolidated for calendar year 2021.

Notably, there are situations in which the Target Group survives its acquisition by the buyer. In these cases, the Target Group survives, but with a new common parent, despite the apparent taxable nature of the acquisition. This generally occurs when Target shareholders receive more than 50% of the stock (by value) in the new common parent in a reverse acquisition.⁵

Example 3. Same facts as Example 1, except that Holding purchases the stock of Target for (a) cash and (b) 51% of Parent’s sole class of stock. Target Group filed consolidated returns for the taxable years prior to Holding’s acquisition of Target.

Because Target’s shareholders received over 50% of Parent stock, the transaction is a reverse acquisition under Reg. section 1.1502-75(d)(3). Consequently, Target Group survives, only with Parent as its new common parent for calendar year 2021. Because Target Group remains in existence, it is not required to file an initial election to file a consolidated return under Reg. section 1.1502-75(a).

As the above examples illustrate, it is important to closely analyze transactions involving consolidated groups to ensure that the correct entity is reported as the group parent going forward. It is especially critical that taxpayers and their advisors review and confirm the specific steps of these transactions as well as any new legal entities formed in connection with the acquisition. Failure to do so may force a taxpayer to later seek relief under Reg. section 301.9100-3 to make a late election to file an initial consolidated return for a newly created affiliated group.

_{¹ “Target Group” refers to an affiliated group of corporations electing to file a U.S. consolidated return.}

_{² Reg. section 1.1502-75(a). Unless otherwise stated or clear from the context, all references to “section” in this memorandum are to the Internal Revenue Code of 1986 (Code), as amended, and all references to “Reg. section” are to the regulations promulgated under the Code.} 

_{³ Reg. section 1.1502-75(a)(1), (h)(2).}

_{⁴ See Reg. section 1.1502-76(c). Under this rule, if a group has filed a consolidated return on or before the due date for the filing of a subsidiary’s separate return (including extensions and determined without regard to the subsidiary’s short period end), then the subsidiary’s separate return for its short period prior to joining the consolidated group is not due until the due date of the consolidated group that it joined (including extensions).}

_{⁵ Reg. section 1.1502-75(d)(3).}