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b.

Basis increased by subsidiary’s tax-exempt income

i.

Deductions that do not reduce subsidiary’s tax basis in its assets are treated as tax-exempt income:

ii.

Dividends received deduction

iii.

Section 199 deduction

c.

Basis reduced by subsidiary’s noncapital, nondeductible expenses, including subsidiary’s share of consolidated income tax liability

d.

Basis reduced by distributions received from subsidiary

B.

Basis in subsidiary stock can be reduced below zero

a.

Creates “excess loss” account

b.

Must be recaptured into income upon sale of subsidiary stock

C.

Carryback and carryforward losses generated by a subsidiary reduce tax basis of subsidiary stock to extent such losses are actually utilized by the consolidated group

a.

Carry backs reduce basis in the year the loss was generated (i.e., current year)

b.

Carry forwards reduce basis in the year the loss is utilized (i.e., future year)

D.

Taxes

a.

Generally treated as nondeductible, noncapital expenditure by subsidiary (thus reducing basis of sub stock)

b.

If paid by parent, reduction is offset by deemed contribution to subsidiary—i.e., sub deemed to have paid the taxes (reducing parent’s stock basis), followed by contribution by parent to sub to reimburse such payment (increasing parent’s stock basis)

c.

Result of b above is to make irrelevant any differences between regs’ allocation of tax liability and tax-sharing agreements by members of group (difference between technical allocation and actual allocation is deemed paid by either parent or sub, and treated as a distribution/contribution, washing out effect of difference on stock basis)

d.

EXAMPLE:

Assume the following income or loss for the PSS Group:

   P   S1   S2Consol

Income/(loss)1,000(500)2,0002,500

Tax (at 35%)  (875)

Allocation—1502  (350)  175  (700)

Actual payments*  (292)      0  (583)

Deemed contributions:

S1 to P (175)

P to S2    117

Net basis adjustments:

Allocated tax  175   (700)

Deemed contributions (175)     117

0

(583)

5

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