Affiliated group

An affiliated group is a collection of two or more corporations that are linked through common stock ownership and typically treated as a single entity for federal income tax purposes. This concept falls under the broader category of taxation, particularly corporate tax law. The primary purpose of identifying an affiliated group is to allow eligible companies to file a consolidated tax return, which can offer certain tax advantages. An affiliated group generally consists of a common parent corporation and one or more subsidiaries that meet specific ownership tests.²²

History and Origin

The concept of an affiliated group and the ability to file consolidated tax returns has a long history in U.S. tax law, evolving significantly over the decades. Consolidated returns first became a feature of the U.S. tax system with the Revenue Act of 1918, which required affiliated corporations to consolidate their income statements for tax purposes. This was initially seen as a means to prevent artificial shifting of profits or losses among related entities to reduce overall tax liability.²¹

Over time, the rules governing affiliated groups and consolidated returns have been refined through various tax acts. For instance, the Tax Reform Act of 1986 introduced significant changes, including stricter definitions and limitations on how groups could utilize losses. These reforms aimed to simplify the tax code and broaden the tax base.¹⁹, ²⁰ Subsequent legislative and regulatory changes have continued to shape the precise definition and implications of an affiliated group, reflecting ongoing efforts to balance tax fairness with economic efficiency.

Key Takeaways

An affiliated group consists of a common parent and its subsidiaries meeting specific ownership thresholds.
The primary benefit for an affiliated group is the ability to file a consolidated tax return, allowing for combined reporting of income and losses.
To qualify, the common parent must own at least 80% of the total voting power and 80% of the total value of the stock of at least one includible subsidiary.
Being an affiliated group can facilitate the offset of losses from one company against the profits of another within the group, potentially reducing the overall taxable income for the group.
The rules for forming and maintaining an affiliated group are outlined in the Internal Revenue Code, specifically Section 1504.¹⁸

Interpreting the Affiliated Group

The core of determining an affiliated group hinges on stringent ownership tests defined by the Internal Revenue Service (IRS). For a group of corporations to qualify as an affiliated group, a common parent corporation must directly own stock that meets two criteria in at least one other includible corporation:

Voting Power Test: The parent must possess at least 80% of the total voting power of the stock of the subsidiary.¹⁷
Value Test: The parent must own stock with a value equal to at least 80% of the total value of the stock of the subsidiary.¹⁶

Furthermore, stock meeting these requirements in each includible corporation (except the common parent) must be owned directly by one or more of the other includible corporations in the chain. This creates a chain of ownership where each link meets the 80% voting power and value thresholds. Certain types of corporations, such as tax-exempt organizations, foreign corporations, and S corporations, are generally excluded from being "includible corporations" for this purpose.¹⁵

Hypothetical Example

Consider "Alpha Corp," a successful holding company. Alpha Corp directly owns 85% of the voting stock and 90% of the total value of the equity of "Beta Solutions," a software development subsidiary. Beta Solutions, in turn, owns 82% of the voting stock and 88% of the total value of the stock of "Gamma Innovations," a research and development firm.

In this scenario, Alpha Corp, Beta Solutions, and Gamma Innovations would form an affiliated group for federal income tax purposes. Alpha Corp is the common parent, meeting the 80% voting power and value tests for Beta Solutions. Beta Solutions, as an includible corporation, then meets these tests for Gamma Innovations. This structure allows the entire group to be treated as a single entity for calculating their federal income tax liability.

Practical Applications

The formation of an affiliated group has several practical applications, predominantly within the realm of taxation. The most significant is the ability to file a consolidated tax return. This allows the group to combine the income and losses of all qualifying members, potentially leading to substantial tax benefits. For example, operating losses from one subsidiary can offset the taxable income of a profitable member within the group. This can significantly reduce the overall tax liability for the entire corporate structure.¹⁴

Consolidated filing also simplifies the tax treatment of intercompany transactions, such as sales of goods or services between members of the group, as many of these transactions are eliminated for consolidated tax purposes. Furthermore, the Securities and Exchange Commission (SEC) generally requires companies to present consolidated financial statements if a parent company has a controlling financial interest in another entity, typically defined as more than 50% ownership. This ensures that investors receive a comprehensive view of the entire economic enterprise, even if it comprises multiple legal entities.¹¹, ¹², ¹³

Limitations and Criticisms

While offering tax benefits and administrative efficiencies, the concept of an affiliated group and consolidated filing also presents certain limitations and faces criticisms. The rules governing what constitutes an includible corporation and the strict 80% voting power and value tests mean that not all related corporate structures qualify. For instance, a joint venture where a parent owns 70% of a company would not typically be part of its affiliated group for tax purposes, even if it has significant influence.¹⁰

A notable criticism, particularly on an international scale, relates to the potential for base erosion and profit shifting (BEPS). Multinational enterprises, often operating through complex affiliated group structures, can employ strategies to artificially shift profits to lower or no-tax jurisdictions, thereby eroding the tax bases of countries where real economic activity occurs.⁹ International organizations like the OECD and G20 have launched initiatives, such as the BEPS Project, to develop a single set of consensus-based international tax rules to combat these practices and ensure profits are taxed where value is created.⁵, ⁶, ⁷, ⁸ These efforts highlight the ongoing challenge for tax authorities like the Internal Revenue Service to prevent misuse of corporate structure while maintaining a predictable tax environment.

Affiliated Group vs. Controlled Group

While both terms refer to groups of related corporations for tax purposes, an affiliated group and a controlled group serve distinct purposes and have different ownership tests.

An affiliated group is primarily defined under Internal Revenue Code Section 1504 for the purpose of filing a consolidated tax return. It requires a common parent to own at least 80% of both the total voting power and the total value of the stock ownership of at least one other includible corporation, and a similar chain of ownership for other subsidiaries.⁴

A controlled group, conversely, is defined under Internal Revenue Code Section 1563 and is generally relevant for other tax provisions, such as those related to employee benefit plans (e.g., qualified retirement plans), small business deductions, or limiting certain tax credits. Controlled groups can be structured as parent-subsidiary, brother-sister, or combined groups, and their ownership thresholds are often different (e.g., 80% for common ownership but sometimes 50% effective control for brother-sister groups). The specific definitions and implications of a controlled group mean that a group of corporations could qualify as a controlled group but not an affiliated group, and vice-versa, depending on the precise ownership structure and the specific tax provision being applied.

FAQs

What is the main benefit of being an affiliated group?

The primary benefit for an affiliated group is the ability to elect to file a consolidated tax return. This allows the group to combine the income and losses of its members, which can reduce the overall taxable income and associated tax liability by offsetting losses from one company against profits from another.

Do all companies in an affiliated group have to file a consolidated return?

No, filing a consolidated tax return is an election, not a requirement. However, once an election is made, all eligible members of the affiliated group must join in the consolidated return for that year and subsequent years unless the group's status terminates or the election is revoked with Internal Revenue Service consent.³

What are the ownership requirements for an affiliated group?

For a group of corporations to be considered an affiliated group, the common parent corporation must directly own at least 80% of the total voting power and at least 80% of the total value of the stock ownership of at least one other includible corporation. Subsequent includible corporations in the chain must meet similar direct ownership requirements by other members of the group.²

Can foreign corporations be part of an affiliated group?

Generally, foreign corporations are explicitly excluded from the definition of "includible corporations" for purposes of forming an affiliated group that can file a consolidated tax return in the U.S.¹ However, U.S. tax law does have provisions for U.S. corporations with foreign subsidiaries that impact their overall tax liability, such as rules for foreign tax credits.

What happens if a subsidiary leaves an affiliated group?

If a subsidiary ceases to meet the 80% voting power and value stock ownership tests, it generally leaves the affiliated group. The departure of a single member does not necessarily terminate the entire affiliated group, but that former member would typically need to file a separate tax return for its portion of the year after leaving the group.