IRS clarifies LIFO recapture when an S corp acquires a consolidated group

Tax Hot Topics - IRS clarifies LIFO recapture when an S Corp acquires a consolidated group The IRS has issued a field attorney advice memorandum (FAA 20153001F) clarifying how recapture from the last-in, first-out (LIFO) method of accounting should be reported on a tax return reporting a single transaction under Section 1363(d)(4)(D) when a C corporation converts to a qualified subchapter S subsidiary.

The FAA addressed an S corporation that acquired the stock of a C corporation. The C corporation was the common parent of an affiliated group that had elected to file a consolidated federal income tax return (the taxpayer group). The S corporation filed qualified subchapter S subsidiary (QSUB) elections for the C corporation and its subsidiary and disregarded entity as of the day after the acquisition. The C corporation filed a final consolidated tax return from the first day of its tax year  through the end of the day of the acquisition (the day immediately before the effective date of the QSUB elections). Thus, pursuant to the QSUB elections and beginning as of the day after the acquisition, the activity of the C corporation and its subsidiary and disregarded entity would be reported on the S corporation’s tax return.  
Importantly, both the subsidiary and disregarded entity used the LIFO inventory accounting method. Thus, under Section 1363(d), the LIFO recapture amount related to this inventory was required to be included in gross income for the last taxable year of the corporation. Section 1363(d)(4)(D), however, provides that the LIFO recapture amount cannot be reported when the corporation at issue is a member of an affiliated group. Thus, the taxpayer group did not report the LIFO recapture amount on its final consolidated tax return. Instead, the C corporation filed a second tax return that was a stand-alone “single transaction return” reporting only the amount of the LIFO recapture.

The IRS Service Center initially rejected the single transaction return. The IRS Associate Area Counsel, however, agreed in the FAA with the C corporation’s filing methodology and instructed the Service Center to process the single transaction return accordingly.

Andy Cordonnier
+1 202 521 1502

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