In May 2012, the IRS released an advisory memo2 addressing whether the parent of a consolidated group can claim a deduction for a subsidiary’s worthless stock when the subsidiary continues to hold tax refund claims. In the memo, the taxpayer (“Taxpayer”) is the common parent of a consolidated group that included an insolvent subsidiary. During the taxable year, Taxpayer’s consolidated group incurred a large consolidated net operating loss (“NOL”), all of which was attributable to the subsidiary. By the end of the tax year, the subsidiary ceased its business operations, disposed of its operating assets, and used the proceeds to pay some of its creditors. The subsidiary continued to hold some assets, including legal claims against its directors and officers, as well as the right to a share of the tax refund attributable to the carryback of the NOL.3 The retained assets were worth less than the amount of the subsidiary’s unpaid liabilities. At first blush, the stock of the subsidiary held by the Taxpayer was worthless under Section4 165(g), which allows holders of worthless stock to treat the stock as disposed of in a sale or exchange in the year in which the stock becomes worthless. Special rules apply, however, to the stock of a subsidiary in a consolidated group. According to Treasury regulations under Section 1502, stock is not considered worthless for Section 165 purposes until all of the subsidiary’s assets are treated as disposed of.5
According to the advisory memo, the subsidiary’s share of the refund claim, as well as its legal claims, constitute property, and therefore the subsidiary has not disposed of all of its assets. As a result, the subsidiary’s stock did not meet the standard for worthlessness set forth in the regulations. The advisory memo notes that until 2008, it was only necessary for a subsidiary to have disposed of “substantially all” of its assets in order to meet the standard for worthlessness. In making this requirement stricter by requiring the disposition of all property (except for its corporate charter or any assets necessary to satisfy state law minimum capital requirements), the regulations sought to “prevent gain or loss on stock from being taken into account by the group until after items flowing from the subsidiary’s activities are taken into account by the group.” This decision appears to reflect a preference for viewing consolidated groups as a single entity, rather than as an aggregation of entities.