Consolidated Tax Return: Definition & Understanding Filing Process

KEY TAKEAWAYS

• A consolidated tax return allows corporations to report their taxes alongside their affiliates as one single reporting entity. 
• This is beneficial to corporations that operate through many different legal entities as it allows them to be seen as one entity. 
• Items that are commonly consolidated include net losses, certain deductions and tax credits, and capital gains. 
• The Internal Revenue Service (IRS) has many rules and definitions. This is as to how companies are legally allowed to consolidate their tax return. 

What Is a Consolidated Tax Return?

A consolidated tax return is a form of corporate income tax return, for corporations, it is Form 1120, Corporate Income Tax Return. It is filed by an affiliated group of corporations that elect to report their combined tax liability on a single consolidated return. Form 851 Affiliations Schedule, and supporting documentation (income reconciliation, balance sheet, computation of taxable income) for each corporation need be attached to the return.

The main aim of the tax return is to allow corporations that run their business through a number of affiliates to be viewed as a single entity. Common items that are consolidated into a tax return include capital gains and net losses. Certain deductions are also consolidated, such as net operating losses and charitable contributions.

Process of Filing a Consolidated Tax Return

The process is relatively straightforward. The parent company files a consolidated tax return. All of these companies’ subsidiaries must begin to follow the tax year of their parent company. These affiliates are also responsible for making certain information available for the consolidated tax return.

Each individual affiliate has to list their own tax information, such as deductions and taxable income. They must also then figure out any transactions that have taken place between companies. These transactions can include any renting of property, lending, or any goods or services sold or bought. 

Next, the affiliates have to report their net income or loss. They must disregard any items that will be consolidated. This should then land them at their separate taxable income. 

Once each affiliate has determined its separate taxable income, the consolidated items are netted across the member companies. This determines the overall consolidated taxable income.

Advantages of Filing a Consolidated Tax Return

An affiliated group that elects to file a consolidated tax return could majorly alter its combined overall tax liability. To give an example, a return that has been consolidated would ignore all sales between connected corporations and any other transactions between companies. This would mean that no tax would be marked. The deferment of taxable losses or taxable sales becomes realized with the ultimate sale to a third party. 

Capital losses and gains can also be spread out across affiliates. The income associated with one affiliated corporation can also be used to offset any losses. These are losses that another affiliated corporation has suffered. Foreign tax credits can also be shared across the different affiliates. 

Disadvantages of Filing a Consolidated Tax Return

When calculating the accumulated earnings tax, the profit and loss of each individual affiliate are included. This can be detrimental to the company as only a single minimum credit amount is able to be used. This means that losses are deferred as well as intercompany income.

Which States Allow Consolidated Tax Returns?

As of today, 24 states and the District of Columbia are allowed to file consolidated state tax returns. The 24 states are as follows: 

1. Alaska
2. Arizona
3. California
4. Colorado
5. Connecticut
6. Hawaii
7. Idaho
8. Illinois
9. Kansas
10. Maine
11. Massachusetts
12. Michigan
13. Minnesota
14. Montana
15. Nebraska
16. New Hampshire
17. New Mexico
18. New York
19. North Dakota
20. Rhode Island
21. Utah
22. Vermont
23. West Virginia
24. Wisconsin

Summary

The effect of filing a consolidated return for multiple affiliate companies can be beneficial, but it is still a very complicated process. It should be noted that careful consideration should be taken before deciding to go for this return option. Any group should consider its overall tax liability relative to separate filings. As well as its eligibility, and the effect this process could have in the future. 

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.