Corporate Tax | Just Tax

Consolidated NOLs and SRLY (Reg. § 1.1502-21)

This checklist guides the analysis of consolidated net operating loss (CNOL) computation, the separate return limitation year (SRLY) rules, and their interaction with section 382 ownership change limitations. Use it whenever a consolidated group acquires a new member with pre-affiliation losses, when computing a group's CNOL deduction, or when determining the extent to which a member's pre-affiliation NOLs or built-in losses may offset income of other group members.

Step 1. The Single-Entity Model and CNOL Computation

"Any excess of deductions over gross income, as determined under § 1.1502-11(a) (without regard to any consolidated net operating loss deduction), is also referred to as the consolidated net operating loss (or CNOL)." (§ 1.1502-21(e))

• The CNOL defined. The CNOL is the excess of deductions over gross income for the consolidated group, computed without regard to any CNOL deduction. (§ 1.1502-21(e))
  • The computation references § 1.1502-11(a), which determines consolidated taxable income (CTI) through a multi-step formula.
  • The CNOL is therefore a pre-deduction measure. It is the loss pool generated by the group's operations before any CNOL carryover or carryback is applied.
  • TRAP. Do not confuse the CNOL (the loss generated in a year) with the CNOL deduction (the amount of prior losses allowed in a later year). See Step 2 below for the CNOL deduction.
  • The CNOL can be negative for some members and positive for others. Only the group-wide excess of deductions over gross income produces a CNOL.
• Consolidated taxable income under § 1.1502-11(a). CTI is determined by taking into account five items in sequence. (§ 1.1502-11(a))
  • First, the separate taxable income of each member. (§ 1.1502-11(a)(1))
  • Second, the CNOL deduction. (§ 1.1502-11(a)(2))
  • Third, consolidated capital gain net income. (§ 1.1502-11(a)(3))
  • Fourth, consolidated section 1231 net loss. (§ 1.1502-11(a)(4))
  • Fifth, the consolidated charitable contributions deduction. (§ 1.1502-11(a)(5))
  • CAUTION. The CNOL is computed BEFORE the CNOL deduction enters the formula. The CNOL deduction is applied in the second step to determine CTI, but the CNOL itself is the residual from step one computed without that deduction.
• Separate taxable income under § 1.1502-12. Each member computes its separate taxable income by reference to its own items of income, gain, deduction, and loss. (§ 1.1502-12)
  • The single-entity model aggregates these separate taxable incomes and permits intra-group offsetting of income and loss. (IRS Field Service Advisory 20251401F)
  • Member-level losses reduce the group's aggregate income even if the loss member has no income of its own. This is the core of the single-entity concept.
  • EXAMPLE. If P (the common parent) has $100 of taxable income and S (a subsidiary) has a $40 loss, the group's CTI before the CNOL deduction is $60. S's loss offsets P's income dollar for dollar.
  • The group's CNOL for a year is the amount by which the aggregate deductions of all members exceed aggregate gross income, as computed through the § 1.1502-11(a) framework without regard to any CNOL deduction.

Step 2. The CNOL Deduction and Its Components

"The consolidated net operating loss deduction for any consolidated return year is the aggregate of the net operating loss carryovers and carrybacks to the year." (§ 1.1502-21(a)(1))

• The CNOL deduction as aggregate of carryovers and carrybacks. The CNOL deduction is not the same as the CNOL. It is the amount of prior-year losses that the group may deduct in the current consolidated return year. (§ 1.1502-21(a)(1))
  • The deduction consists of two distinct components enumerated in § 1.1502-21(a)(1)(i) and (ii).
  • Component (i) consists of "any CNOLs (as defined in paragraph (e) of this section) of the consolidated group." These are losses the group itself generated in prior consolidated return years.
  • Component (ii) consists of "any net operating losses (or NOLs) of the members arising in separate return years." These are pre-affiliation losses of individual members.
  • TRAP. Component (ii) losses are subject to the SRLY limitation. See Step 5 for the SRLY definition and later steps for the SRLY cumulative register computation.
• Net operating loss carryovers and carrybacks defined. The terms carryover and carryback track the statutory framework of section 172 as implemented in the consolidated context. (§ 1.1502-21(a)(1))
  • A carryover is an NOL from a prior taxable year that is carried forward to the current year under section 172(b).
  • A carryback is an NOL from a later taxable year that is carried back to the current year under section 172(b).
  • The consolidated regulations apply section 172 principles "as provided by paragraph (a)(2) of this section." (§ 1.1502-21(a)(2)(i))
  • Pre-2018 NOLs generally carry back 2 years and forward 20 years. Post-2017 NOLs (for non-farm, non-insurance corporations arising in years beginning after December 31, 2020) carry forward indefinitely and carry back 0 years. See Step 4 for the post-2017 limitation framework.
• Limitations on the CNOL deduction. The CNOL deduction is "subject to any limitations under the Internal Revenue Code or this chapter." (§ 1.1502-21(a)(1))
  • § 172(a)(2) imposes an 80-percent limitation on post-2017 NOLs. See Step 4.
  • § 1.1502-21(c) imposes the SRLY limitation on losses arising in separate return limitation years. See Steps 5 and beyond.
  • § 382 may impose an ownership change limitation. The interaction of SRLY and section 382 is governed by § 1.1502-21(g).
  • § 1.1502-21(a)(2) provides the specific framework for applying section 172(a)(2) in the consolidated context. (§ 1.1502-21(a)(2)(i))
  • CAUTION. Apply limitations in the correct order. The SRLY limitation and the 80-percent limitation operate as independent constraints. A loss must satisfy both to be deductible.

Step 3. Carryover and Carryback Mechanics

"The net operating loss carryovers and carrybacks to a taxable year are determined under the principles of section 172 and this section. Thus, losses permitted to be absorbed in a consolidated return year generally are absorbed in the order of the taxable years in which they arose, and losses carried from taxable years ending on the same date, and which are available to offset consolidated taxable income for the year, generally are absorbed on a pro rata basis." (§ 1.1502-21(b)(1))

• Ordering rule for loss absorption. Losses are absorbed oldest first. When multiple losses arise in taxable years ending on the same date, they are absorbed on a pro rata basis. (§ 1.1502-21(b)(1))
  • Oldest-loss-first means a Year 1 CNOL is absorbed before a Year 2 CNOL.
  • Pro-rata absorption applies only when losses from the same year are available. If P carries over $120 from Year 3 and T carries over $6 (after SRLY limits) from Year 3, and remaining available income is $38, P absorbs ($120 / $126) times $38 = $36.19 and T absorbs ($6 / $126) times $38 = $1.81. (§ 1.1502-21(c)(1)(iii)(B), Example 2(B))
  • This ordering applies to both CNOLs of the group and NOLs of members arising in separate return years. The two pools are ordered independently within their respective categories.
• Apportionment of absorbed CNOL among members. When a CNOL is absorbed by the group, the portion attributable to each member is determined by a percentage formula. (§ 1.1502-21(b)(2)(iv)(B)(1))
  • "The percentage of the CNOL for the consolidated return year attributable to a member equals the separate net operating loss of the member for the consolidated return year divided by the sum of the separate net operating losses for that year of all members having such losses for that year."
  • "The separate net operating loss of a member is determined by computing the CNOL by reference to only the member's items of income, gain, deduction, and loss, including the member's losses and deductions actually absorbed by the group in the consolidated return year (whether or not absorbed by the member)."
  • If a member's portion is absorbed or reduced on a non-pro rata basis, the percentage is recomputed. The recomputed percentage equals the remaining CNOL attributable to the member divided by the sum of remaining CNOL attributable to all remaining members. (§ 1.1502-21(b)(2)(iv)(B)(2))
  • EXAMPLE. If a CNOL of $100 is generated by a group with P contributing $80 and S contributing $20 of loss, P is attributed 80% and S is attributed 20% of any absorbed amount.
• Carryovers and carrybacks to separate return years. When a CNOL attributable to a member may be carried to a separate return year of that member, the amount is apportioned to the member as an "apportioned loss." (§ 1.1502-21(b)(2)(i))
  • "If carried back to a separate return year, the apportioned loss may not be carried back to an equivalent, or earlier, consolidated return year of the group. If carried over to a separate return year, the apportioned loss may not be carried over to an equivalent, or later, consolidated return year of the group."
  • This rule prevents the same loss from being used twice, once in the consolidated context and again in the separate return context for overlapping years.
  • TRAP. Track the apportioned loss carefully. The prohibition on carrying to an equivalent consolidated return year is an anti-duplication rule that requires precise year-by-year tracking.
• Year of departure rule. If a corporation ceases to be a member during a consolidated return year, its NOL carryovers are subject to a special sequencing rule. (§ 1.1502-21(b)(2)(ii)(A))
  • "Net operating loss carryovers attributable to the corporation are first carried to the consolidated return year, then are subject to reduction under section 108 and § 1.1502-28, and then are subject to reduction under § 1.1502-36."
  • "Only the amount that is neither absorbed by the group in that year nor reduced under section 108 and § 1.1502-28 or under § 1.1502-36 may be carried to the corporation's first separate return year."
  • This means the departing member's losses remain available to the group for the year of departure. Only the residual survives for the member's separate return use.
  • CAUTION. The sequence is mandatory. First apply the loss against group income in the departure year. Then apply section 108 discharge of indebtedness reductions under § 1.1502-28. Then apply § 1.1502-36 stock loss rules. Only then may the remainder follow the departing member.

Step 4. The Post-2017 80-Percent NOL Limitation

"The amount of any net operating loss deduction under this section shall be the lesser of (A) the aggregate amount of net operating losses arising in taxable years beginning before January 1, 2018, carried to such taxable year, or (B)(i) the aggregate amount of net operating losses arising in taxable years beginning after December 31, 2017, carried to such taxable year, or (ii) 80 percent of the excess (if any) of (I) taxable income computed without regard to the deductions under this section and sections 199A and 250, over (II) the amount determined under subparagraph (A)." (section 172(a)(2))

• Two-tier framework for pre-2018 and post-2017 NOLs. § 1.1502-21(a)(2)(i) implements section 172(a)(2) in the consolidated context by establishing two tiers of NOL treatment. (§ 1.1502-21(a)(2)(i))
  • Tier 1. Pre-2018 CNOLs (losses from taxable years beginning before January 1, 2018) are deductible without limitation under section 172(a). These losses are applied first.
  • Tier 2. Post-2017 CNOLs (losses from taxable years beginning after December 31, 2017) are deductible only up to 80 percent of the excess of CTI (computed without regard to CNOL deductions under sections 172, 199A, and 250) over pre-2018 CNOLs already deducted.
  • "Following the deduction of pre-2018 CNOLs, this paragraph (a)(2) applies to compute the maximum amount of CNOLs from taxable years beginning after December 31, 2017 (post-2017 CNOLs), that can be deducted against taxable income in a consolidated return year beginning after December 31, 2020 (post-2017 CNOL deduction limit)." (§ 1.1502-21(a)(2)(i))
  • TRAP. The 80-percent cap applies to the group's CTI computation, not member-by-member. A single member with post-2017 SRLY NOLs cannot avoid the cap by pointing to another member's income.
• Special rule for nonlife insurance companies under section 172(f). Nonlife insurance companies (as defined in section 816(a)) are not subject to the 80-percent limitation. (section 172(f))
  • "The taxable income of nonlife insurance companies may be fully offset by NOL deductions." (IRS T.D. 9927)
  • Losses of nonlife insurance companies arising in taxable years beginning after December 31, 2020, may be carried back two years and carried over 20 years. (section 172(b)(1)(C) and (b)(1)(D)(i))
  • This exception applies at the member level. If a consolidated group includes a nonlife insurance company member, that member's post-2017 NOLs are not subject to the 80-percent cap even though other members' losses are.
• Two-pool approach for mixed groups under § 1.1502-21(a)(2)(iii)(C). For groups with at least one nonlife insurance company member and at least one non-insurance member, the post-2017 CNOL deduction limit is computed using two income pools. (§ 1.1502-21(a)(2)(iii)(C)(1))
  • The post-2017 CNOL deduction limit equals the lesser of (i) the aggregate amount of post-2017 NOLs carried to the year, or (ii) the sum of the residual income pool and the nonlife income pool. (§ 1.1502-21(a)(2)(iii)(C)(1))
  • The residual income pool (for non-insurance members) equals 80 percent of the excess of the group's CTI (excluding nonlife insurance company items and disregarding sections 172, 199A, and 250 deductions) over pre-2018 NOLs allocated to that pool. (§ 1.1502-21(a)(2)(iii)(C)(2))
  • The nonlife income pool (for nonlife insurance company members) equals the group's CTI (excluding non-nonlife items) less pre-2018 NOLs allocated to that pool, with no 80-percent cap applied. (§ 1.1502-21(a)(2)(iii)(C)(3))
  • Pre-2018 NOLs are prorated between the two pools based on the relative amounts of positive income in each pool. (§ 1.1502-21(a)(2)(iii)(C)(4))
  • EXAMPLE. If $30 of pre-2018 NOLs is carried to a year in which the residual income pool contains $75 and the nonlife income pool contains $150, the residual pool gets $10 ($30 times $75 / $225) and the nonlife pool gets $20 ($30 times $150 / $225).
  • CAUTION. If one pool is positive and the other is negative, the post-2017 CNOL deduction limit equals the lesser of aggregate post-2017 NOLs or 80 percent of the group's entire CTI (disregarding sections 172, 199A, and 250) after subtracting all pre-2018 NOLs. The pool generating the positive income defines the character. (§ 1.1502-21(a)(2)(iii)(C)(5)(i))
• Farming loss rules under section 172(b)(1)(B). A farming loss receives special carryback treatment. (section 172(b)(1)(B)(i))
  • "The term 'farming loss' means the lesser of (I) the amount which would be the net operating loss for the taxable year if only income and deductions attributable to farming businesses (as defined in section 263A(e)(4)) are taken into account, or (II) the amount of the net operating loss for such taxable year." (section 172(b)(1)(B)(ii))
  • A farming loss may be carried back to each of the 2 taxable years preceding the loss year. (section 172(b)(1)(B)(i))
  • A taxpayer may elect to waive the 2-year carryback. The election is irrevocable and must be made by the due date (including extensions) for the return for the loss year. (section 172(b)(1)(B)(iv))
  • In the consolidated context, the maximum amount of farming loss is the CNOL of the group rather than the NOL of the specific member generating the loss. (IRS T.D. 9927)
  • The group's farming loss is allocated to each member based on the percentage of the CNOL attributable to the member under § 1.1502-21(b)(2)(iv)(B), regardless of whether the member engaged in farming activities. (§ 1.1502-21(b)(2)(iv)(D))
  • § 1.1502-21(b)(2)(iv)(D) does not apply to farming losses incurred in taxable years beginning after December 31, 2017, and before January 1, 2021, because the CARES Act provided a 5-year carryback for all NOLs in those years. (§ 1.1502-21(b)(2)(iv)(D))

Step 5. SRLY Definition and Scope

"The term separate return limitation year (or SRLY) means any separate return year of a member or of a predecessor of a member." (§ 1.1502-1(f)(1))

• SRLY defined as any separate return year of a member or predecessor. The definition sweeps broadly to capture all pre-affiliation taxable years of an acquired member. (§ 1.1502-1(f)(1))
  • "The term separate return year means a taxable year of a corporation for which it files a separate return or for which it joins in the filing of a consolidated return by another group." (§ 1.1502-1(e))
  • A SRLY therefore includes two categories of years. First, any year the member filed its own separate return. Second, any year the member joined in filing a consolidated return with a different group.
  • The definition also captures separate return years of a predecessor of a member. Predecessor and successor are defined in § 1.1502-1(f)(4) to include section 381(a) transactions and carryover basis transactions on or after January 1, 1997.
  • TRAP. A member's years in a different consolidated group are SRLYs. If T was a member of the Q consolidated group before joining the P group, all of T's years in the Q group are SRLYs for purposes of the P group. The SRLY subgroup rules in § 1.1502-21(c)(2) may mitigate this. See later steps.
• The anti-trafficking purpose of the SRLY rules. Congress and Treasury designed SRLY to prevent the trafficking in net operating losses through corporate acquisitions.
  • The SRLY limitation ensures that a subsidiary's pre-affiliation losses may only offset income generated by that subsidiary (or its SRLY subgroup) after joining the acquiring group.
  • "The net effect [of the Lonely Parent rule] is to allow pre-affiliation NOL's of the common parent to be used to offset post-affiliation profits of any member of the group." (Wolter Construction Co. v. Commissioner, 634 F.2d 1029, 1034 (6th Cir. 1980))
  • The asymmetry is deliberate. The common parent's pre-affiliation losses are not SRLYs (the "lonely parent" exception under § 1.1502-1(f)(2)(i)), but a subsidiary's pre-affiliation losses are trapped by SRLY.
  • Wolter Construction Co. v. Commissioner, 634 F.2d 1029 (6th Cir. 1980), affirmed the Tax Court's disallowance of approximately $125,255 of River Hills' pre-affiliation NOL carryovers that Wolter (the parent) had used to offset the group's consolidated income. The Sixth Circuit held that River Hills' pre-affiliation NOLs were deductible only against River Hills' own post-affiliation income, not against Wolter's income, confirming the core SRLY principle that pre-affiliation losses of a subsidiary remain trapped at the subsidiary level.
  • EXAMPLE. P acquires T in Year 2. T has a $50 NOL from Year 1 (a separate return year). In Year 2, the P group has $200 of CTI, all generated by P. T has no income in Year 2. The $50 T NOL is a SRLY NOL. Because T has contributed nothing to the group's CTI, the SRLY limitation bars any use of the $50 NOL in Year 2. The $50 carries forward subject to the cumulative register.
• Exceptions to SRLY status. Three principal exceptions narrow the broad definition. (§ 1.1502-1(f)(2))
  • The lonely parent exception. A separate return year of the corporation that is the common parent for the consolidated return year to which the tax attribute is carried is not a SRLY. (§ 1.1502-1(f)(2)(i)) This exception is subject to the reverse acquisition rule in § 1.1502-1(f)(3).
  • The all-year member exception. A separate return year of any corporation that was a member of the group for each day of such year is not a SRLY. (§ 1.1502-1(f)(2)(ii)) This applies when a subsidiary was a member from its first day of existence through the last day of the year. Short tax years and mid-year acquisitions do not qualify.
  • The predecessor exception. A separate return year of a predecessor of any member is not a SRLY if the predecessor was a member of the group for each day of such year. (§ 1.1502-1(f)(2)(iii))
  • CAUTION. The lonely parent exception does NOT apply in a reverse acquisition. Under § 1.1502-1(f)(3), if corporation P merges into corporation T and the former P shareholders own more than 50 percent of T, all taxable years of the first corporation (T in form) and its subsidiaries ending on or before the acquisition date are treated as SRLYs, while the separate return years of the second corporation (P) and its subsidiaries are not SRLYs.
• Built-in losses treated as arising in SRLYs. § 1.1502-15 operates in tandem with the SRLY rules to limit built-in losses.
  • "Built-in losses are treated as deductions or losses in the year recognized, except for the purpose of determining the amount of, and the extent to which the built-in loss is limited by, the SRLY limitation for the year in which it is recognized. Solely for such purpose, a built-in loss is treated as a hypothetical net operating loss carryover or net capital loss carryover arising in a SRLY, instead of as a deduction or loss in the year recognized." (§ 1.1502-15(a))
  • To the extent a built-in loss is allowed, it offsets consolidated taxable income before any loss carryovers or carrybacks. To the extent not allowed, it is treated as a separate NOL carryover arising in the year of recognition, and that year is treated as a SRLY for the converted loss. (§ 1.1502-15(a))
  • "The treatment under § 1.1502-15 of a built-in loss as a hypothetical net operating loss carryover in the year recognized is solely for purposes of determining the limitation under this paragraph (c) with respect to the loss in that year and not for any other purpose." (§ 1.1502-21(c)(1)(i)(D))
  • This means a built-in loss is analyzed under the SRLY cumulative register in the recognition year even though it is technically a current-year item. See later steps for the cumulative register computation.

Step 6. Exceptions to SRLY Status

"(f)(1) In general. Except as provided in paragraphs (f)(2) and (3) of this section, the term separate return limitation year (or SRLY) means any separate return year of a member or of a predecessor of a member." (§ 1.1502-1(f)(1))

• The general rule. Any separate return year of a member or predecessor is a SRLY unless an exception in § 1.1502-1(f)(2) or (f)(3) applies. The term "separate return year" means a taxable year of a corporation for which it files a separate return or for which it joins in the filing of a consolidated return by another group. (§ 1.1502-1(e)) Thus, a SRLY includes both standalone separate return years and years filed with a different consolidated group.

Step 6A. The Lonely Parent Exception

"(f)(2) Exceptions. The term separate return limitation year (or SRLY) does not include: (i) A separate return year of the corporation which is the common parent for the consolidated return year to which the tax attribute is to be carried (except as provided in § 1.1502-75(d)(2)(ii) and paragraph (f)(3) of this section)" (§ 1.1502-1(f)(2)(i))

• Rationale. The common parent is treated as the embodiment of the consolidated group itself, even for years when it had no subsidiaries. Its pre-affiliation NOLs may offset post-affiliation income of any group member without SRLY limitation. (Wolter Constr. Co. v. Commissioner, 634 F.2d 1029, 1034 (6th Cir. 1980) ("The net effect is to allow pre-affiliation NOL's of the common parent to be used to offset post-affiliation profits of any member of the group").)
• Scope limitation. This exception applies only to the corporation that IS the common parent for the year to which the attribute is carried. If the attribute is carried to a year in which a different corporation serves as common parent, the lonely parent exception does not apply to the former common parent.
• Reverse acquisition override. The lonely parent exception does not apply when § 1.1502-1(f)(3) (reverse acquisition) applies. In a reverse acquisition, the first corporation's years become SRLYs and the second corporation's years retain non-SRLY status, effectively reversing the normal lonely parent rule. (§ 1.1502-1(f)(3).)
• Prospective limitation. The lonely parent exception is prospective only. The former common parent does not retain lonely parent status indefinitely after the group terminates. (CCA 200441026 (Oct. 8, 2004).)
• CAUTION. This exception applies only to the corporation that IS the common parent for the year to which the attribute is carried. A former common parent that joins a new group as a subsidiary does not qualify for the lonely parent exception.
• TRAP. In a reverse acquisition, the former common parent of the first corporation does not retain lonely parent status. The reverse acquisition exception redirects the SRLY limitation to the ostensibly acquiring corporation. (CCA 200441026 (citing Wolter Constr. Co., 634 F.2d at 1035-1036).)

Step 6B. The All-Year Member Exception

"(f)(2)(ii) A separate return year of any corporation which was a member of the group for each day of such year" (§ 1.1502-1(f)(2)(ii))

• Application. This exception applies when a subsidiary was a member for the entire taxable year. The classic case is a subsidiary formed during the year that was a member from its first day of existence.
• Mid-year acquisitions excluded. A corporation that joins mid-year and files a short-period return is NOT eligible. The exception requires membership for each day of the taxable year.
• Rationale. Because the corporation was already part of the group for the entire year, there is no trafficking concern.

Step 6C. The Predecessor Exception

"(f)(2)(iii) A separate return year of a predecessor of any member if such predecessor was a member of the group for each day of such year." (§ 1.1502-1(f)(2)(iii))

• Two conditions. First, the year must be a separate return year of a predecessor. Second, the predecessor must have been a member of the group for each day of that year.
• Predecessor definition. The term "predecessor" means a transferor or distributor of assets to a member in a transaction to which § 381(a) applies, or a carryover basis transaction on or after January 1, 1997. (§ 1.1502-1(f)(4).)
• Application. This exception prevents a former group member's historical year from becoming a SRLY merely because a successor corporation later joins a different group.

Step 6D. The Reverse Acquisition Exception

"(f)(3) Reverse acquisitions. In the event of an acquisition to which § 1.1502-75(d)(3) applies, all taxable years of the first corporation and of each of its subsidiaries ending on or before the date of the acquisition are treated as separate return limitation years, and the separate return years (if any) of the second corporation and each of its subsidiaries are not treated as separate return limitation years (unless they were so treated immediately before the acquisition)." (§ 1.1502-1(f)(3))

• Substance over form. In a reverse acquisition, the first corporation is the acquiror in form but the target in substance. The second corporation is the target in form but the continuing group in substance. (§ 1.1502-75(d)(3).)
• SRLY status reversed. All taxable years of the first corporation and its subsidiaries ending on or before the acquisition date are treated as SRLYs. The separate return years of the second corporation and its subsidiaries are NOT treated as SRLYs.
• Regulatory illustration. If corporation P merges into corporation T, and the stockholders of P own more than 50 percent of T after the merger, then a loss incurred before the merger by T (even though it is the common parent) is treated as having been incurred in a SRLY. Conversely, a loss incurred before the merger by P is treated as having been incurred in a year that is NOT a SRLY. (§ 1.1502-1(f)(3), Example.)
• Prospective application only. The reverse acquisition exception applies only to the transaction at hand. The former common parent does not retain lonely parent status indefinitely after the group terminates. (CCA 200441026.)
• TRAP. The reverse acquisition exception is prospective only. The former common parent does NOT retain lonely parent status indefinitely after the group terminates. Once the group terminates and the former common parent files separate returns, its subsequent separate return years are SRLYs if it later joins another group.
• Interaction with lonely parent. CCA 200441026 held that in a reverse acquisition, § 1.1502-1(f)(3) treats all pre-acquisition years of the acquiring (first) corporation as SRLYs. The separate return years of the target (second) corporation are generally NOT treated as SRLYs. But this treatment applies prospectively. The former common parent does not retain lonely parent status indefinitely after the group terminates.

Step 7. The SRLY Cumulative Register

"(c)(1)(i) General rule. Except as provided in paragraph (g) of this section (relating to an overlap with section 382), the aggregate of the net operating loss carryovers and carrybacks of a member (SRLY member) arising (or treated as arising) in SRLYs (SRLY NOLs) that are included in the CNOL deductions for all consolidated return years of the group under paragraph (a) of this section may not exceed the aggregate consolidated taxable income for all consolidated return years of the group determined by reference to only the member's items of income, gain, deduction, and loss (cumulative register)." (§ 1.1502-21(c)(1)(i))

• Core concept. The SRLY limitation operates as a cumulative running account. Each year, the group's consolidated taxable income computed by reference to only the SRLY member's items is added to or subtracted from the register. SRLY NOLs can only be deducted to the extent of the positive balance in this cumulative register.
• Scope. The limitation applies to SRLY NOL carryovers and carrybacks included in CNOL deductions for all consolidated return years of the group. It does not apply to non-SRLY NOLs.

Step 7A. Exclusion of CNOL Deductions from CTI

"(A) Consolidated taxable income is computed without regard to CNOL deductions" (§ 1.1502-21(c)(1)(i)(A))

• Purpose. When computing the cumulative register, the group's consolidated taxable income does NOT take into account any CNOL deductions. This ensures the register measures the member's raw contribution to the group's income, not income already reduced by loss absorption.
• Application. If the group deducted a $100 CNOL in Year 1, the cumulative register for Year 1 is computed as if no CNOL deduction had been taken.

Step 7B. Inclusion of Actually Absorbed Losses

"(B) Consolidated taxable income takes into account the member's losses and deductions (including capital losses) actually absorbed by the group in consolidated return years (whether or not absorbed by the member)" (§ 1.1502-21(c)(1)(i)(B))

• Reduction of register. The member's losses and deductions that the group actually used reduce the cumulative register, even if those losses were absorbed by other members. This prevents the register from being inflated by income that is subsequently offset by the member's own losses.
• EXAMPLE. If T (a SRLY member) generates $100 of income but the group absorbs $40 of T's current-year losses against that income, the cumulative register increases by only $60 ($100 income less $40 losses absorbed).

Step 7C. Scope of Years Included

"(C) In computing consolidated taxable income, the consolidated return years of the group include only those years, including the year to which the loss is carried, that the member has been continuously included in the group's consolidated return, but exclude-- (1) For carryovers, any years ending after the year to which the loss is carried; and (2) For carrybacks, any years ending after the year in which the loss arose" (§ 1.1502-21(c)(1)(i)(C))

• Continuous inclusion required. The cumulative register includes only years during which the member was continuously part of the group. If the member leaves and rejoins, the years of absence are excluded.
• Carryover exclusion. For carryovers, any years ending AFTER the year to which the loss is carried are excluded. The register looks backward and to the current year only.
• Carryback exclusion. For carrybacks, any years ending after the year in which the loss arose are excluded. The register looks backward from the loss year only.

Step 7D. Built-in Losses as Hypothetical NOL Carryovers

"(D) The treatment under § 1.1502-15 of a built-in loss as a hypothetical net operating loss carryover in the year recognized is solely for purposes of determining the limitation under this paragraph (c) with respect to the loss in that year and not for any other purpose. Thus, for purposes of determining consolidated taxable income for any other losses, a built-in loss allowed under this section in the year it arises is taken into account" (§ 1.1502-21(c)(1)(i)(D))

• Sole purpose rule. Built-in losses under § 1.1502-15 are treated as hypothetical NOL carryovers ONLY for determining how much of the built-in loss the SRLY limitation allows. This is a timing and character rule solely for SRLY limitation purposes.
• All other purposes. For all other purposes, including computing the cumulative register for OTHER losses, the built-in loss is treated as a current-year deduction.
• Cross-reference. See Step 9 for the full built-in loss rules under § 1.1502-15.

Step 7E. Coordination with the 80-Percent Limitation

"(E) If a limitation on the amount of taxable income that may be offset under section 172(a) (see paragraph (a)(2) of this section) applies in a taxable year to a member whose carryovers or carrybacks are subject to a SRLY limitation (SRLY member), the amount of net operating loss subject to a SRLY limitation that is available for use by the group in that year is limited to the percentage of the balance in the cumulative register that would be available for offset under section 172(a) if the SRLY member filed a separate return and reported as taxable income in that year the amount contained in the cumulative register." (§ 1.1502-21(c)(1)(i)(E))

• Two limitations apply. The SRLY limitation is applied ON TOP OF the § 172(a) limitation. The group must satisfy both.
• How the limitation works. The SRLY limitation equals the percentage of the balance in the cumulative register that would be available under § 172(a) if the SRLY member filed a separate return reporting the cumulative register amount as taxable income. For a post-2017 NOL, this means 80 percent of the cumulative register balance.
• CRITICAL register reduction. The cumulative register is reduced by the FULL amount of income needed to support the SRLY NOL absorption, not just the portion actually used. If the cumulative register is $120 and the § 172(a) limitation is 80 percent, the SRLY limitation is $96 ($120 times 80 percent). But the cumulative register is reduced by $120 (the full income needed to support $96 of absorption at 80 percent), not by $96.
• Regulatory numerical example. Assume a consolidated group has a SRLY member that is a corporation other than a nonlife insurance company, and the SRLY member has a SRLY NOL that arose in a taxable year beginning after December 31, 2017. The group's consolidated taxable income for a consolidated return year beginning after December 31, 2020 is $200, but the cumulative register has a positive balance of only $120 (and no other NOL carryovers or carrybacks are available). Because the SRLY limitation is $96 ($120 times 80 percent), only $96 of SRLY loss may be used, rather than $160 ($200 times 80 percent). The cumulative register is decreased by the full amount of income required under § 172(a) to support the amount of SRLY NOL absorption ($120). (§ 1.1502-21(c)(1)(i)(E), Example.)
• TRAP. Do not reduce the cumulative register by only the amount of NOL actually absorbed. Reduce it by the FULL amount of income that would be required under § 172(a) to support that absorption.

Step 7F. Losses Treated as Arising in SRLYs

"(ii) If a net operating loss carryover or carryback did not arise in a SRLY but is attributable to a built-in loss (as defined under § 1.1502-15), the carryover or carryback is treated for purposes of this paragraph (c) as arising in a SRLY if the built-in loss was not allowed, after application of the SRLY limitation, in the year it arose." (§ 1.1502-21(c)(1)(ii))

• Conversion rule. If a built-in loss is DISALLOWED in the year recognized because of the SRLY limitation, the disallowed portion is converted into an actual NOL carryover. The year of recognition is TREATED AS a SRLY for that carryover.
• Effect. The converted loss now has SRLY status, meaning it remains subject to the cumulative register limitation in future years.
• Cross-reference. See Step 9 for the built-in loss absorption priority and conversion mechanics.

Step 8. SRLY Subgroups

"(c)(2) SRLY subgroup limitation. In the case of a net operating loss carryover or carryback for which there is a SRLY subgroup, the principles of paragraph (c)(1) of this section apply to the SRLY subgroup, and not separately to its members. Thus, the contribution to consolidated taxable income and the net operating loss carryovers and carrybacks arising (or treated as arising) in SRLYs that are included in the CNOL deductions for all consolidated return years of the group under paragraph (a) of this section are based on the aggregate amounts of income, gain, deduction, and loss of the members of the SRLY subgroup for the relevant consolidated return years." (§ 1.1502-21(c)(2))

• Core principle. When a SRLY subgroup exists, the SRLY limitation applies to the subgroup in the aggregate, not separately to individual members. This allows affiliated corporations that joined a group together to aggregate their cumulative registers, preventing the SRLY limitation from being applied member-by-member.

Step 8A. Carryover Subgroup Composition

"(i) Carryovers. In the case of a carryover, the SRLY subgroup is composed of the member carrying over the loss (the loss member) and each other member that was a member of the former group that becomes a member of the group at the same time as the loss member. A member remains a member of the SRLY subgroup until it ceases to be affiliated with the loss member." (§ 1.1502-21(c)(2)(i))

• Composition. The carryover subgroup includes the loss member plus each other member of the former group that becomes a member of the new group at the same time as the loss member.
• Duration. A member remains in the SRLY subgroup until it ceases to be affiliated with the loss member. This means the subgroup can shrink but does not automatically expand.

Step 8B. Carryback Subgroup Composition

"(ii) Carrybacks. In the case of a carryback, the SRLY subgroup is composed of the member carrying back the loss (the loss member) and each other member of the group from which the loss is carried back that has been continuously affiliated with the loss member from the year to which the loss is carried through the year in which the loss arises." (§ 1.1502-21(c)(2)(ii))

• Continuous affiliation test. For carrybacks, the subgroup includes the loss member plus each other member of the former group that was continuously affiliated with the loss member from the carryback year through the loss year.
• Rationale. This ensures that only corporations that were affiliated during the entire relevant period can aggregate their registers for carryback purposes.

Step 8C. Built-in Loss Subgroup Composition

"(iii) Built-in losses. In the case of a built-in loss, the SRLY subgroup is composed of the member recognizing the loss (the loss member) and each other member that was part of the subgroup with respect to the loss determined under § 1.1502-15(c)(2) immediately before the members became members of the group." (§ 1.1502-21(c)(2)(iii))

• Cross-reference to § 1.1502-15(c)(2). The built-in loss subgroup is determined under the § 1.1502-15(c)(2) subgroup rules, not under the carryover or carryback rules.
• 60-month continuous affiliation. A subgroup under § 1.1502-15(c)(2) is composed of those members that have been continuously affiliated with each other for the 60 consecutive month period ending immediately before they become members of the group in which the loss is recognized. (§ 1.1502-15(c)(2).)
• Duration. A member remains a member of the subgroup until it ceases to be affiliated with the loss member. (§ 1.1502-15(c)(2).)

Step 8D. Subgroup Anti-Avoidance Rule

"(iv) Principal purpose of avoiding or increasing a SRLY limitation. The members composing a SRLY subgroup are not treated as a SRLY subgroup if any of them is formed, acquired, or availed of with a principal purpose of avoiding the application of, or increasing any limitation under, this paragraph (c). Any member excluded from a SRLY subgroup, if excluded with a principal purpose of so avoiding or increasing any SRLY limitation, is treated as included in the SRLY subgroup." (§ 1.1502-21(c)(2)(iv))

• Two-way rule. The IRS can deny subgroup treatment if any member was formed, acquired, or availed of with a principal purpose of avoiding or increasing a SRLY limitation. Conversely, a member actually excluded from the subgroup is treated as INCLUDED if the exclusion had a principal purpose of avoiding or increasing the limitation.
• Principal purpose standard. This is a facts-and-circumstances test. The IRS must show that the principal purpose of the transaction was SRLY manipulation.

Step 8E. Coordination with Other Limitations

"(v) Coordination with other limitations. This paragraph (c)(2) does not allow a net operating loss to offset income to the extent inconsistent with other limitations or restrictions on the use of losses, such as a limitation based on the nature or activities of members. For example, a net operating loss may not offset income in excess of any limitations under section 172(a) and paragraph (a)(2) of this section. Additionally, any dual consolidated loss may not reduce the taxable income to an extent greater than that allowed under section 1503(d) and §§ 1.1503(d)-1 through 1.1503(d)-8." (§ 1.1502-21(c)(2)(v))

• Hierarchy of limitations. The SRLY subgroup rule does not override other limitations. The § 172(a) limitation, dual consolidated loss rules under § 1503(d), and any activity-based limitations still apply.

Step 8F. Anti-Duplication Rule

"(vi) Anti-duplication. If the same item of income or deduction could be taken into account more than once in determining a limitation under this paragraph (c), or in a manner inconsistent with any other provision of the Internal Revenue Code or regulations incorporating this paragraph (c), the item of income or deduction is taken into account only once and in such manner that losses are absorbed in accordance with the ordering rules in paragraph (b) of this section and the underlying purposes of this section." (§ 1.1502-21(c)(2)(vi))

• Purpose. This rule prevents the same item of income from being counted multiple times to inflate the cumulative register.
• Ordering. Items are taken into account in a manner consistent with the loss absorption ordering rules in § 1.1502-21(b).

Step 8G. Corporations That Leave a Subgroup

"(vii) Corporations that leave a SRLY subgroup. If a loss member ceases to be affiliated with a SRLY subgroup, the amount of the member's remaining SRLY loss from a specific year is determined pursuant to the principles of paragraphs (b)(2)(ii)(A) and (b)(2)(iv) of this section." (§ 1.1502-21(c)(2)(vii))

• Prorated separation. When a loss member ceases to be affiliated with the subgroup, its remaining SRLY loss is determined under the CNOL apportionment principles of § 1.1502-21(b)(2)(ii)(A) and (b)(2)(iv).
• Cross-reference. See Step 5 (CNOL absorption ordering) for the apportionment mechanics.

Step 8H. Successor Net Positive Income Exclusion

"(f)(2) Limitation on SRLY subgroups--(i) General rule. Except as provided in paragraph (f)(2)(ii) of this section, if a successor's items of income and gain exceed the successor's items of deduction and loss (net positive income), then the net positive income attributable to the successor is excluded from the computation of the consolidated taxable income of a SRLY subgroup." (§ 1.1502-21(f)(2)(i))

• General exclusion. If a successor corporation has net positive income (income and gains exceeding deductions and losses), that net positive income is generally EXCLUDED from the SRLY subgroup's cumulative register. This prevents subgroup register inflation from unrelated successor income.

"(ii) Exceptions. A successor's net positive income is not excluded from the consolidated taxable income of a SRLY subgroup if-- (A) The successor acquires substantially all the assets and liabilities of its predecessor and the predecessor ceases to exist; (B) The successor was a member of the SRLY subgroup when the SRLY subgroup members became members of the group; (C) 100 percent of the stock of the successor is owned directly by corporations that were members of the SRLY subgroup when the SRLY subgroup members became members of the group; or (D) The Commissioner so determines." (§ 1.1502-21(f)(2)(ii))

• Exception (A) - Complete acquisition. The exclusion does not apply if the successor acquires substantially all the assets and liabilities of its predecessor and the predecessor ceases to exist. The successor is effectively the same business.
• Exception (B) - Subgroup membership. The exclusion does not apply if the successor was already a member of the SRLY subgroup when the subgroup members joined the group.
• Exception (C) - 100 percent ownership. The exclusion does not apply if 100 percent of the successor's stock is owned directly by corporations that were SRLY subgroup members when the subgroup joined the group.
• Exception (D) - Commissioner discretion. The Commissioner may determine that exclusion is inappropriate.

Step 8I. Deemed Continuous Affiliation for Overlap

"(c)(3) Coordination of 60 month affiliation requirement with the overlap rule. If one or more corporations become members of a group and are included in the determination of a net unrealized built-in loss that is subject to the overlap rule described in paragraph (g)(1) of this section, then for purposes of paragraph (c)(2) of this section, such corporations that become members of the group are treated as having been affiliated for 60 consecutive months with the common parent of the group and are also treated as having been affiliated with any other members who have been affiliated or are treated as having been affiliated with the common parent at such time." (§ 1.1502-15(c)(3))

• Overlap facilitation. When the SRLY and § 382 limitations overlap, the SRLY subgroup rules can still function because the regulations treat overlap-transaction members as having met the 60-month affiliation requirement.
• Partial application rule. If two or more corporations become members at the same time but this deemed affiliation rule does not apply to every such corporation, then immediately after joining, the corporations to which the rule applies are treated as having not been previously affiliated with the corporations to which it does not apply. (§ 1.1502-15(c)(3), second sentence.)
• Cross-reference. See Step 10 for the full overlap rules under § 1.1502-21(g).

Step 9. Built-in Losses Under § 1.1502-15

"(a) SRLY limitation. Except as provided in paragraph (f) of this section (relating to built-in losses of the common parent) and paragraph (g) of this section (relating to an overlap with section 382), built-in losses are subject to the SRLY limitation under §§ 1.1502-21(c) and 1.1502-22(c) (including applicable subgroup principles). Built-in losses are treated as deductions or losses in the year recognized, except for the purpose of determining the amount of, and the extent to which the built-in loss is limited by, the SRLY limitation for the year in which it is recognized. Solely for such purpose, a built-in loss is treated as a hypothetical net operating loss carryover or net capital loss carryover arising in a SRLY, instead of as a deduction or loss in the year recognized. To the extent that a built-in loss is allowed as a deduction under this section in the year it is recognized, it offsets any consolidated taxable income for the year before any loss carryovers or carrybacks are allowed as a deduction. To the extent not so allowed, it is treated as a separate net operating loss or net capital loss carryover or carryback arising in the year of recognition and, under § 1.1502-21(c) or 1.1502-22(c), the year of recognition is treated as a SRLY." (§ 1.1502-15(a))

• General rule. Built-in losses are subject to the SRLY limitation. They are treated as deductions in the year recognized EXCEPT for SRLY limitation purposes. Solely for SRLY limitation purposes, they are treated as hypothetical NOL carryovers arising in a SRLY.

Step 9A. Absorption Priority

• Built-in losses first. To the extent a built-in loss is allowed under the SRLY limitation, it offsets consolidated taxable income BEFORE any actual loss carryovers or carrybacks are allowed. (§ 1.1502-15(a), third sentence.)
• Practical effect. Built-in losses have priority over actual NOL carryovers. If a SRLY member has both built-in losses and SRLY NOL carryovers, the built-in losses absorb income first, potentially leaving no room for the carryovers.

Step 9B. Disallowed Portion Converted to Actual NOL

• Conversion mechanism. To the extent a built-in loss is NOT allowed in the year of recognition because of the SRLY limitation, the disallowed portion is treated as a separate NOL carryover arising in the year of recognition. That year is then treated as a SRLY for the converted loss. (§ 1.1502-15(a), fourth sentence. See also § 1.1502-21(c)(1)(ii).)
• Cross-reference. See Step 7 for the interaction between converted losses and the cumulative register.

Step 9C. Net Unrealized Built-in Loss and Threshold

"(b) Built-in loss. An asset has a built-in loss if, immediately before the corporation that owns the asset becomes a member of the group (or, if earlier, immediately before another event that results in the asset becoming a tainted asset), the asset's adjusted basis for federal income tax purposes would, if the asset were then sold for its fair market value, result in a loss that would be taken into account for federal income tax purposes. The amount of the built-in loss is the amount of that loss." (§ 1.1502-15(b))

• Test. Compare adjusted basis to fair market value immediately before the corporation becomes a group member. If basis exceeds FMV, the asset has a built-in loss equal to the excess.
• NUBIL threshold. The aggregate built-in losses must exceed the lesser of (i) $10,000,000 or (ii) 15 percent of the FMV of the corporation's assets (excluding cash and cash items). If the net unrealized built-in loss does not exceed this threshold, it is treated as zero. (§ 382(h)(3)(B).)
• 5-year recognition period. Built-in losses recognized during the 5-year period beginning on the date the corporation becomes a member of the group are subject to the SRLY limitation. (§ 382(h)(7)(A). See also § 1.1502-15(b).)

Step 9D. Subgroup Rules for Built-in Losses

• Built-in loss subgroup composition. The SRLY subgroup for built-in losses is composed of the member recognizing the loss and each other member that was part of the subgroup under § 1.1502-15(c)(2) immediately before joining the group. (§ 1.1502-21(c)(2)(iii).)
• 60-month affiliation. Members must have been continuously affiliated with each other for the 60 consecutive month period ending immediately before they became members of the new group. (§ 1.1502-15(c)(2).)
• Cross-reference. See Step 8 for the carryover and carryback subgroup rules.

Step 8D. Subgroup Anti-Avoidance Rule for Common Parent Losses

"(f) Built-in losses recognized by common parent of group--(1) General rule. Paragraph (a) of this section does not apply to any loss recognized by the group on an asset held by the common parent on the date the group is formed. Following an acquisition described in § 1.1502-75(d)(2) or (3), references to the common parent are to the corporation that was the common parent immediately before the acquisition. (2) Anti-avoidance rule. If a corporation that becomes a common parent of a group acquires assets with a net unrealized built-in loss in excess of the threshold requirement of section 382(h)(3)(B) (and thereby increases its net unrealized built-in loss or decreases its net unrealized built-in gain) prior to, and in anticipation of, the formation of the group, paragraph (f)(1) of this section does not apply." (§ 1.1502-15(f))

• Lonely parent rule for built-in losses. Losses on assets held by the common parent when the group is formed are NOT subject to the SRLY limitation on built-in losses. This parallels the lonely parent exception for NOLs. (§ 1.1502-15(f)(1).)
• Anti-avoidance override. If the common parent acquires built-in loss assets prior to and in anticipation of forming the group, and the acquired NUBIL exceeds the § 382(h)(3)(B) threshold, the exception does not apply. (§ 1.1502-15(f)(2).)
• TRAP. If a common parent stuffs itself with built-in loss assets before forming a group to avoid SRLY limitation, the anti-avoidance rule applies and the built-in losses are subject to SRLY.

Step 9F. Overlap with § 382

• General overlap rule. The SRLY limitations on built-in losses do not apply when there is an overlap with § 382. (§ 1.1502-15(g)(1).)
• Same six-month rule. An overlap occurs if a corporation becomes a member within six months of the change date of an ownership change giving rise to a § 382(a) limitation that would apply to the recognized built-in losses. (§ 1.1502-15(g)(2)(ii)(A).)
• No identity of loss required. The overlap applies even if the NUBIL composition differs between the § 382 event date and the SRLY event date. (§ 1.1502-15(g)(2)(ii)(A).)
• Subgroup coextensiveness. The same coextensiveness requirement applies. All members of the SRLY subgroup must be in the loss subgroup and vice versa. (§ 1.1502-15(g)(4).)
• Cross-reference. See Step 10 for the detailed overlap mechanics.

Step 9G. Asset Acquisition Exception That Breaks Overlap

"Paragraph (g)(1) of this section does not apply, however, if a corporation that would otherwise be subject to the overlap rule acquires assets from a person other than a member of the group with a net unrealized built-in loss in excess of the threshold requirement of section 382(h)(3)(B) (and thereby increases its net unrealized built-in loss or decreases its net unrealized built-in gain) prior to, and in anticipation of, becoming a member of the group." (§ 1.1502-15(g)(3)(ii))

• Anti-trafficking provision. An overlap that would otherwise exist is BROKEN if the corporation acquires assets with a NUBIL exceeding the § 382(h)(3)(B) threshold from a non-member prior to and in anticipation of joining the group.
• Policy. This prevents taxpayers from stuffing a target corporation with loss assets before an acquisition to trigger overlap and avoid SRLY limitation.
• Cross-reference. See Step 10 for the analogous asset acquisition exception under § 1.1502-21(g).

Step 10. SRLY Overlap with § 382

"(g) Overlap with section 382--(1) General rule. The limitation provided in paragraph (c) of this section does not apply to net operating loss carryovers (other than a hypothetical carryover described in paragraph (c)(1)(i)(D) of this section and a carryover described in paragraph (c)(1)(ii) of this section) when the application of paragraph (c) of this section results in an overlap with the application of section 382. For a similar rule applying in the case of net operating loss carryovers described in paragraphs (c)(1)(i)(D) and (c)(1)(ii) of this section, see § 1.1502-15(g)." (§ 1.1502-21(g)(1))

• Core principle. When the SRLY limitation and the § 382 limitation would both apply to the same NOL carryover, the SRLY limitation is ELIMINATED. Only § 382 applies.
• Scope limitation. The overlap rule applies to NOL carryovers only. It does NOT apply to hypothetical carryovers from built-in losses under § 1.1502-15 or carryovers treated as arising in SRLYs under § 1.1502-21(c)(1)(ii). For those, see § 1.1502-15(g). (§ 1.1502-21(g)(1).)
• Hierarchy. § 1.1502-21(c)(1)(i) begins "Except as provided in paragraph (g) of this section (relating to an overlap with section 382)..." This creates a statutory hierarchy. § 382 limitation supersedes SRLY limitation when overlap conditions are met.

Step 10A. Definitions and the Six-Month Rule

"(2) Definitions--(i) Generally. For purposes of this paragraph (g), the definitions and nomenclature contained in section 382, the regulations thereunder, and §§ 1.1502-90 through 1.1502-99 apply." (§ 1.1502-21(g)(2)(i))

• All § 382 terminology incorporated. Ownership change, change date, testing period, loss corporation, and all other § 382 terms apply for overlap purposes.

"(ii) Overlap.--(A) An overlap of the application of paragraph (c) of this section and the application of section 382 with respect to a net operating loss carryover occurs if a corporation becomes a member of a consolidated group (the SRLY event) within six months of the change date of an ownership change giving rise to a section 382(a) limitation with respect to that carryover (the section 382 event)." (§ 1.1502-21(g)(2)(ii)(A))

• Temporal proximity test. The overlap exists when a SRLY event (becoming a member) occurs within six months of the § 382 change date.
• Nomenclature. The SRLY event is the date the corporation becomes a group member. The § 382 event is the ownership change giving rise to a § 382(a) limitation. The change date is the date of the ownership change under § 382(g).
• No same-date requirement. The SRLY event and § 382 event need not occur on the same date. Proximity within six months is sufficient.

Step 10B. Interim Losses

"(B) If an overlap described in paragraph (g)(2)(ii)(A) of this section occurs with respect to net operating loss carryovers of a corporation whose SRLY event occurs within the six month period beginning on the date of a section 382 event, then an overlap is treated as also occurring with respect to that corporation's net operating loss carryover that arises within the period beginning with the section 382 event and ending with the SRLY event." (§ 1.1502-21(g)(2)(ii)(B))

• Anti-avoidance for interim NOLs. If the SRLY event occurs within six months after the § 382 event, any NOLs arising in the interim period (between the two events) are ALSO covered by the overlap rule.
• Purpose. This prevents artificial planning to avoid overlap by generating new losses between the § 382 event and the SRLY event.
• EXAMPLE. If the § 382 event is January 1 and the SRLY event is April 1, and the corporation generates an NOL in February, that February NOL is also covered by the overlap rule.

Step 10C. Operating Rules

"(3) Operating rules--(i) Section 382 event before SRLY event. If a SRLY event occurs on the same date as a section 382 event or within the six month period beginning on the date of the section 382 event, paragraph (g)(1) of this section applies beginning with the tax year that includes the SRLY event." (§ 1.1502-21(g)(3)(i))

• § 382 event first. When the SRLY event occurs on or after the § 382 event (but within six months), the overlap applies beginning with the tax year that includes the SRLY event. If both events occur simultaneously, the overlap applies immediately.
• SRLY limitation eliminated prospectively. From the tax year containing the SRLY event forward, the SRLY limitation does not apply to the relevant carryovers.

"(ii) SRLY event before section 382 event. If a section 382 event occurs within the period beginning the day after the SRLY event and ending six months after the SRLY event, paragraph (g)(1) of this section applies starting with the first tax year that begins after the section 382 event." (§ 1.1502-21(g)(3)(ii))

• SRLY event first. When the SRLY event precedes the § 382 event (by up to six months), the overlap applies starting with the first tax year beginning after the § 382 event.
• Interim period subject to SRLY. The member's losses are subject to SRLY limitation from the SRLY event through the end of the tax year including the § 382 event. Only after that does the overlap become operative.
• TRAP. If the SRLY event precedes the § 382 event, the SRLY limitation still applies during the interim period. Do not assume overlap applies immediately from the SRLY event.

Step 10D. Asset Acquisition Exception

• Breaking the overlap. The overlap rule does NOT apply if the corporation acquires assets from a non-member with a NUBIL exceeding the § 382(h)(3)(B) threshold prior to and in anticipation of joining the group. (§ 1.1502-15(g)(3)(ii), applied by analogy under § 1.1502-21(g).)
• Policy rationale. This prevents taxpayers from stuffing a target with loss assets before an acquisition to manufacture overlap and avoid the SRLY limitation.
• Effect. If the exception applies, BOTH the SRLY limitation AND the § 382 limitation apply to the carryovers.
• Cross-reference. See Step 9 for the analogous built-in loss rule.

Step 10E. Subgroup Rules and Coextensiveness

"(4) Subgroup rules. In general, in the case of a net operating loss carryover for which there is a SRLY subgroup and a loss subgroup (as defined in § 1.1502-91(d)(1)), the principles of this paragraph (g) apply to the SRLY subgroup, and not separately to its members. However, paragraph (g)(1) of this section applies-- (i) With respect to a carryover described in paragraph (g)(2)(ii)(A) of this section only if-- (A) All members of the SRLY subgroup with respect to that carryover are also included in a loss subgroup with respect to that carryover; and (B) All members of a loss subgroup with respect to that carryover are also members of a SRLY subgroup with respect to that carryover; and (ii) With respect to a carryover described in paragraph (g)(2)(ii)(B) of this section only if all members of the SRLY subgroup for that carryover are also members of a SRLY subgroup that has net operating loss carryovers described in paragraph (g)(2)(ii)(A) of this section that are subject to the overlap rule of paragraph (g)(1) of this section." (§ 1.1502-21(g)(4))

• Subgroup-level application. The overlap rule applies at the subgroup level, not member-by-member. But it applies only when the SRLY subgroup and the § 382 loss subgroup are COEXTENSIVE.
• Coextensiveness requirement. Every member of the SRLY subgroup must be in the loss subgroup. AND every member of the loss subgroup must be in the SRLY subgroup. (§ 1.1502-21(g)(4)(i)(A) and (B).)
• Non-coextensive result. If the SRLY subgroup and loss subgroup are not coextensive for carryovers described in (g)(2)(ii)(A), the overlap rule does NOT apply. The losses remain subject to BOTH the SRLY limitation AND the § 382 limitation. (§ 1.1502-21(g)(4)(i).)
• Interim losses condition. For interim losses under (g)(2)(ii)(B), overlap applies only if all members of the SRLY subgroup for the interim losses are also in a SRLY subgroup whose carryovers described in (g)(2)(ii)(A) are already subject to overlap. (§ 1.1502-21(g)(4)(ii).)
• TRAP. If the acquiring group structures the acquisition so that SRLY subgroup members differ from loss subgroup members, the overlap rule can be defeated and both limitations will apply.

Step 10F. Key Examples

• Simultaneous acquisition with coextensive subgroups (overlap applies). Individual A owns all of S, which owns all of T. S and T file a consolidated return. B owns all of P. In Year 2, the S group has a $200 CNOL ($100 attributable to S, $100 to T). At the beginning of Year 3, P acquires all of S. P's acquisition results in S and T becoming members of the P group (SRLY event). S and T compose a SRLY subgroup. S and T also compose a loss subgroup under § 1.1502-91(d)(1). The acquisition also results in an ownership change of S (the subgroup parent) (§ 382 event). Because the SRLY subgroup and loss subgroup are coextensive, the overlap rule applies and the SRLY limitation does not apply. (§ 1.1502-21(g)(5), Example 5.)
• Different subgroups (no overlap). B owns all of P. P owns all of S and all of T. A owns all of X. In Year 1, the P group has a $200 CNOL ($100 S, $100 T). At the beginning of Year 3, X acquires all of S and T from P (no election under § 1.1502-91(d)(4)). X's acquisition is the SRLY event. S and T compose a SRLY subgroup. But S and T do NOT bear a § 1504(a)(1) relationship to each other. Therefore, they do NOT qualify as a loss subgroup. X's acquisition results in separate ownership changes of S and T with separate § 382 limitations. Although the SRLY event and § 382 change dates occur on the same date, the overlap rule does NOT apply because the subgroups are NOT coextensive. The Year 1 NOL is subject to BOTH the SRLY subgroup limitation AND separate § 382 limitations for S and T. (§ 1.1502-21(g)(5), Example 6.)
• § 382 event before SRLY event with gap (no overlap). P and S file a consolidated return. T has owned 60 percent of X for 6 years. For Year 1, X has a $500 NOL carried forward. On March 31, Year 2, T purchases an additional 30 percent of X (X becomes a member of the P group, SRLY event). On December 31, Year 2, T purchases the remaining 10 percent of X (ownership change under § 382(g), § 382 event). The SRLY event (March 31) is more than six months before the § 382 event (December 31). There is NO overlap. The Year 1 NOL is subject to BOTH the SRLY limitation and the § 382 limitation. (§ 1.1502-21(g)(5), Example 3.)
• SRLY event before § 382 event (overlap after interim period). S has owned 40 percent of T for 6 years. For Year 6, T has a $500 NOL carried forward. On March 31, Year 7, S acquires an additional 40 percent of T (SRLY event). On August 31, Year 7, S acquires the remaining 20 percent of T (§ 382 event). The SRLY event (March 31) occurred within six months of the § 382 event (August 31). There is an overlap. The SRLY rules apply to Year 7 (the year including the SRLY event). Beginning in Year 8 (the first tax year beginning after the § 382 event), any unabsorbed portion of the Year 6 NOL is NOT subject to SRLY limitation. (§ 1.1502-21(g)(5), Example 4.)
• Subsequent acquisition without § 382 event (SRLY reapplies). In Year 1, D incurs a $100 NOL carried forward. At the beginning of Year 3, R acquires D (SRLY event AND § 382 event on the same date). Overlap applies. D's Year 1 NOL is NOT subject to SRLY limitation in the R group. In Year 5, M acquires R (no ownership change of R). No § 382 event occurs. Therefore, no overlap in the M group. D's Year 1 NOL IS subject to SRLY limitation in the M group. The SRLY subgroup for the M group includes R, D, and all other members of the R group that joined at the same time. (§ 1.1502-21(g)(5), Example 8.)
• Interim losses with different subgroups. In Year 1, the S group has a $100 CNOL. On January 1, Year 2, P acquires S. On December 31, Year 2, M acquires 51 percent of P (§ 382 event). On May 31, Year 3, M acquires the remaining 49 percent of P (SRLY event for P, S, T joining M group). Year 3 pre-June 1, the P group has a $50 CNOL attributable to S. The December 31 purchase is the § 382 event. The May 31 purchase is the SRLY event. The SRLY event is within six months of the § 382 change date, so overlap exists for the Year 1 NOL. S and T compose coextensive SRLY and loss subgroups for the Year 1 NOL. Overlap applies. For the Year 3 interim loss, P, S, and T compose the SRLY subgroup. But P is NOT in the loss subgroup. Therefore, the Year 3 interim loss IS subject to SRLY limitation in the M group. (§ 1.1502-21(g)(5), Example 9.)
• CAUTION. When interim losses are involved, check whether ALL members of the SRLY subgroup for the interim loss are also in a SRLY subgroup whose pre-existing carryovers are already subject to overlap. If not, the interim losses remain subject to SRLY.

Step 11. SRLY Overlap with § 383 for Capital Losses

"(g) Overlap with section 383 -- (1) General rule. The limitation provided in paragraph (c) of this section does not apply to net capital loss carryovers (other than a hypothetical carryover like those described in Section 1.1502-21(c)(1)(i)(D) and a carryover like those described in Section 1.1502-21(c)(1)(ii)) when the application of paragraph (c) of this section results in an overlap with the application of section 383." § 1.1502-22(g)(1).

"(2) Definitions -- (i) Generally. For purposes of this paragraph (g), the definitions and nomenclature contained in sections 382 and 383, the regulations thereunder, and Sections 1.1502-90 through 1.1502-99 apply." § 1.1502-22(g)(2)(i).

• The general rule. The SRLY limitation in § 1.1502-22(c) does not apply to net capital loss carryovers when application of that limitation would result in overlap with § 383. (§ 1.1502-22(g)(1)) This is the capital loss analogue to the § 382 overlap rule for NOLs in § 1.1502-21(g). Hypothetical carryovers described in § 1.1502-21(c)(1)(i)(D) and carryovers described in § 1.1502-21(c)(1)(ii) are excluded from the general overlap rule. For those items, see § 1.1502-15(g).
• Definitions and nomenclature. All definitions and nomenclature contained in § 382, § 383, the regulations thereunder, and §§ 1.1502-90 through 1.1502-99 apply for purposes of the overlap determination. (§ 1.1502-22(g)(2)(i))
• The six-month overlap test. An overlap of the application of § 1.1502-22(c) and the application of § 383 with respect to a net capital loss carryover occurs if a corporation becomes a member of the consolidated group (the SRLY event) within six months of the change date of an ownership change giving rise to a § 382 limitation with respect to that carryover (the § 383 event). (§ 1.1502-22(g)(2)(ii)(A)) The SRLY event and the § 383 event need not occur on the same date. Proximity within six months is sufficient.
• Interim losses. If an overlap occurs with respect to net capital loss carryovers of a corporation whose SRLY event occurs within the six month period beginning on the date of a § 383 event, then an overlap is treated as also occurring with respect to that corporation's net capital loss carryover that arises within the period beginning with the § 383 event and ending with the SRLY event. (§ 1.1502-22(g)(2)(ii)(B)) This prevents artificial planning to avoid overlap by generating new capital losses between the two events.
• Operating rules parallel to § 1.1502-21(g)(3).
  • If a SRLY event occurs on the same date as a § 383 event or within the six month period beginning on the date of the § 383 event, § 1.1502-22(g)(1) applies beginning with the tax year that includes the SRLY event. (§ 1.1502-22(g)(3)(i))
  • If a § 383 event occurs within the period beginning the day after the SRLY event and ending six months after the SRLY event, § 1.1502-22(g)(1) applies starting with the first tax year that begins after the § 383 event. (§ 1.1502-22(g)(3)(ii))
• Subgroup coextensiveness requirement. Paragraph (g)(1) applies only if the SRLY subgroup and the loss subgroup (as defined in § 1.1502-91(d)(1)) are coextensive. (§ 1.1502-22(g)(4)) Every member of the SRLY subgroup must also be in the loss subgroup, and every member of the loss subgroup must also be in the SRLY subgroup. If the subgroups are not coextensive, the capital loss carryover remains subject to both the SRLY limitation and the § 383 limitation. See Step 12 of this checklist for discussion of predecessor and successor rules that may affect subgroup composition.
• Reference to § 1.1502-15(g). For a similar overlap rule applying to hypothetical carryovers from built-in losses (the carryovers excluded from the general rule in § 1.1502-22(g)(1)), see § 1.1502-15(g). The built-in loss overlap rule mirrors the structure of § 1.1502-22(g) but applies specifically to recognized built-in losses and carryovers attributable to recognized built-in losses.

Step 12. Predecessor and Successor Rules

"(f)(1) In general. For purposes of this section, any reference to a corporation, member, common parent, or subsidiary, includes, as the context may require, a reference to a successor or predecessor, as defined in § 1.1502-1(f)(4)." § 1.1502-21(f)(1).

"(4) Predecessor and successors. The term predecessor means a transferor or distributor of assets to a member (the successor) in a transaction -- (i) To which section 381(a) applies; or (ii) That occurs on or after January 1, 1997, in which the successor's basis for the assets is determined, directly or indirectly, in whole or in part, by reference to the basis of the assets of the transferor or distributor, but in the case of a transaction that occurs before June 25, 1999, only if the amount by which basis differs from value, in the aggregate, is material. For a transaction that occurs before June 25, 1999, only one member may be considered a predecessor to or a successor of one other member." § 1.1502-1(f)(4).

• The general rule of succession. Any reference to a corporation, member, common parent, or subsidiary in § 1.1502-21 includes, as the context may require, a reference to a successor or predecessor as defined in § 1.1502-1(f)(4). (§ 1.1502-21(f)(1)) This means that a SRLY member's predecessor's separate return years are treated as SRLYs of the member, and a successor may inherit a member's cumulative register balance subject to the limitations below.
• Two categories of predecessor. § 1.1502-1(f)(4) defines predecessor in two ways. First, a transferor or distributor of assets to a member in a transaction to which § 381(a) applies. (§ 1.1502-1(f)(4)(i)) This covers taxable mergers, Type A reorganizations, and liquidations of a subsidiary into its parent. Second, a transferor or distributor in a carryover basis transaction occurring on or after January 1, 1997, in which the successor's basis for the assets is determined by reference to the transferor's basis. (§ 1.1502-1(f)(4)(ii))
• Materiality and one-to-one limitations for pre-1999 transactions. For transactions that occurred before June 25, 1999, the carryover basis predecessor rule applies only if the aggregate amount by which basis differs from value is material. (§ 1.1502-1(f)(4)(ii)) In addition, for transactions before that date, only one member may be considered a predecessor to or a successor of one other member. These restrictions do not apply to transactions on or after June 25, 1999.
• Successor's net positive income excluded from subgroup computation. Except as provided in § 1.1502-21(f)(2)(ii), if a successor's items of income and gain exceed the successor's items of deduction and loss (net positive income), the net positive income attributable to the successor is excluded from the computation of the consolidated taxable income of a SRLY subgroup. (§ 1.1502-21(f)(2)(i)) This prevents a subgroup from artificially inflating its cumulative register by bringing in a successor that generates income unrelated to the loss member's business.
• Four exceptions to net positive income exclusion. A successor's net positive income is not excluded from the SRLY subgroup computation if any of the following conditions is met. (§ 1.1502-21(f)(2)(ii))
  • (A) The successor acquires substantially all the assets and liabilities of its predecessor and the predecessor ceases to exist.
  • (B) The successor was a member of the SRLY subgroup when the SRLY subgroup members became members of the group.
  • (C) 100 percent of the stock of the successor is owned directly by corporations that were members of the SRLY subgroup when the SRLY subgroup members became members of the group.
  • (D) The Commissioner so determines.
• CCA 20251401F (2025) on income shifting through predecessor rules. In CCA 20251401F (Apr. 4, 2025), the IRS rejected a taxpayer's attempt to use the predecessor and successor rules under § 1.1502-21(f)(1) to shift cumulative SRLY register income across entities in a spin-off. The taxpayer sought to allocate income from entities that remained with the distributing corporation to a spun-off entity for SRLY register purposes. The IRS concluded that "Nothing in [the 1991 preamble] links the cumulative register principles to the application of the predecessor and successor rules. Rather, the only reference to use of cumulative registers in the context of the predecessor rules in the preamble is that the regulations are purposed to generally disallow such use." The IRS characterized the requested treatment as "an inappropriate expansion of the SRLY limitation." (CCA 20251401F)
• TRAP. The predecessor and successor rules expand SRLY concepts to account for corporate restructuring but do not allow inappropriate use of one member's historic contribution to consolidated taxable income by another member. A successor inherits a predecessor's SRLY attributes only as the context requires. Practitioners should not use these rules to shift cumulative register income from one entity to another in a manner that circumvents the SRLY limitation. CCA 20251401F (2025) confirms that the IRS will challenge such attempts.
• CAUTION. When a transaction involves both a § 381(a) transfer and a SRLY member, confirm that the predecessor-successor relationship is genuine and not created with a principal purpose of avoiding the SRLY limitation. The anti-avoidance rule in § 1.1502-21(c)(2)(iv) applies to exclude members formed, acquired, or availed of with a principal purpose of increasing any SRLY limitation.

Step 13. Capital Loss SRLY Limitation Under § 1.1502-22(c)

"(c) Limitations on net capital loss carryovers and carrybacks from separate return limitation years. The aggregate of the net capital losses of a member arising (or treated as arising) in SRLYs that are included in the determination of consolidated capital gain net income for all consolidated return years of the group under paragraph (a) of this section may not exceed the aggregate of the consolidated capital gain net income for all consolidated return years of the group determined by reference to only the member's items of gain and loss from capital assets as defined in section 1221 and trade or business assets defined in section 1231(b), including the member's losses actually absorbed by the group in the taxable year (whether or not absorbed by the member). The principles of § 1.1502-21(c) (including the SRLY subgroup principles under § 1.1502-21(c)(2)) apply with appropriate adjustments for purposes of applying this paragraph (c)." § 1.1502-22(c).

• Parallel SRLY limitation for capital losses. The aggregate of a member's net capital losses arising (or treated as arising) in SRLYs that are included in consolidated capital gain net income may not exceed the aggregate consolidated capital gain net income determined by reference to only that member's items. (§ 1.1502-22(c)) This limitation is the direct analogue to the NOL SRLY limitation in § 1.1502-21(c)(1)(i). Every principle discussed in prior steps regarding the NOL cumulative register applies with appropriate adjustments to capital losses.
• Scope of the capital loss cumulative register. The cumulative register for capital losses is computed by reference to only the member's items of gain and loss from capital assets as defined in § 1221 and trade or business assets as defined in § 1231(b). (§ 1.1502-22(c)) Unlike the NOL cumulative register, which includes all income and deduction items, the capital loss register is limited to capital and § 1231 items. Ordinary income and deduction items do not enter the capital loss cumulative register.
• Absorbed losses reduce the register. The member's capital losses actually absorbed by the group in the taxable year reduce the cumulative register, whether or not absorbed by the member itself. (§ 1.1502-22(c)) This mirrors § 1.1502-21(c)(1)(i)(B) for NOLs. If the group uses the SRLY member's capital losses to offset capital gains of other members, those absorbed losses still reduce the member's capital loss cumulative register.
• Principles of § 1.1502-21(c) apply with adjustments. All principles of § 1.1502-21(c), including the subgroup principles under § 1.1502-21(c)(2), apply with appropriate adjustments for capital loss purposes. (§ 1.1502-22(c)) This means that SRLY subgroups for capital losses are composed under the same affiliation and carryover rules as NOL SRLY subgroups. See Step 11 for the overlap of these subgroup rules with § 383.
• Subgroup rules for capital losses. A SRLY subgroup for capital loss carryovers is composed using the same structural rules as for NOL carryovers. For carryovers, the subgroup includes the loss member and each other member that was a member of the former group that becomes a member of the new group at the same time as the loss member. (§ 1.1502-21(c)(2)(i), applied through § 1.1502-22(c)) The subgroup continues until a member ceases to be affiliated with the loss member. The 60-month continuous affiliation test in § 1.1502-15(c)(2) applies by analogy.
• Interaction with § 1.1502-21(c)(1)(i)(D) on built-in capital losses. Built-in capital losses are treated as hypothetical capital loss carryovers solely for purposes of determining the SRLY limitation in the year recognized. (§ 1.1502-21(c)(1)(i)(D)) To the extent a built-in capital loss is allowed in the recognition year, it offsets consolidated capital gain net income before any actual capital loss carryovers. To the extent not allowed, it is treated as a separate net capital loss carryover arising in the year of recognition, and that year is treated as a SRLY for the converted loss. (§ 1.1502-21(c)(1)(ii))
• CAUTION. Do not confuse the capital loss cumulative register with the NOL cumulative register. A member may have a positive balance in its NOL cumulative register (from ordinary income) while having a zero or negative capital loss cumulative register. Capital loss carryovers can only offset capital gain net income, and the SRLY limitation for capital losses is computed independently from the NOL SRLY limitation.

Step 14. Judicial Doctrines and Anti-Trafficking Rules

"In the case of any transaction to which the economic substance doctrine is relevant, such transaction shall be treated as having economic substance only if -- (A) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer's economic position, and (B) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction." § 7701(o)(1).

"The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended." Gregory v. Helvering, 293 U.S. 465, 469 (1935).

"Simply an operation having no business or corporate purpose -- a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner." Gregory v. Helvering, 293 U.S. at 470.

• The economic substance doctrine. A transaction has economic substance only if it changes in a meaningful way the taxpayer's economic position and the taxpayer has a substantial purpose for the transaction, each apart from Federal income tax effects. (§ 7701(o)(1)) This codified doctrine can override technically compliant SRLY structures. Even when every regulatory requirement for SRLY loss absorption is satisfied, the economic substance doctrine may deny the tax benefit if the underlying acquisition or restructuring lacks substance. In Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006), the Federal Circuit held that a transaction without economic substance is disregarded regardless of taxpayer motive, and the taxpayer bears the burden of proving economic substance.
• The step-transaction doctrine. If a series of steps are part of a single plan, they may be collapsed and treated as one transaction for tax purposes. In Intermountain Lumber Co. v. Commissioner, 65 T.C. 1025 (1976), the Tax Court held that a binding pre-exchange commitment to divest stock defeats the control requirement for nonrecognition treatment under § 351. The principle applies directly to SRLY planning. A pre-arranged series of transactions designed to circumvent SRLY limitations -- such as a planned acquisition followed by a planned reorganization to shift losses -- may be collapsed under the step-transaction doctrine, causing the SRLY event to be recharacterized or disregarded.
• Substance over form and the business purpose doctrine. In Gregory v. Helvering, 293 U.S. 465 (1935), the Supreme Court held that a transaction with no business purpose other than tax avoidance may be disregarded even if it literally complies with statutory requirements. The Court found that a reorganization "brought into existence for no other purpose" and immediately liquidated after performing its tax function was a "mere device" that could not claim tax-free treatment. (293 U.S. at 470) Applied to SRLY, an acquisition of a loss corporation that has no legitimate business purpose other than to access its NOLs may be disregarded in whole or in part.
• Anti-abuse rules in the regulations. The consolidated return regulations contain several targeted anti-abuse provisions.
  • § 1.1502-21(c)(2)(iv) denies SRLY subgroup treatment if any member is formed, acquired, or availed of with a principal purpose of avoiding the application of, or increasing any limitation under, the SRLY rules.
  • § 1.1502-21(g)(3) contains an asset acquisition exception that breaks the § 382 overlap rule if a corporation acquires assets with a net unrealized built-in loss from a nonmember prior to, and in anticipation of, becoming a group member. This prevents stuffing a target with loss assets to trigger overlap.
  • § 1.1502-15(f) applies an anti-avoidance rule to built-in losses of the common parent. If a corporation that becomes a common parent acquires assets with a net unrealized built-in loss in excess of the § 382(h)(3)(B) threshold prior to, and in anticipation of, forming the group, the lonely parent exception for built-in losses does not apply.
• The anti-trafficking purpose of SRLY. The SRLY rules exist to prevent acquisition of corporations solely for their tax losses. Every SRLY analysis should confirm a legitimate business purpose for the acquisition. As the Federal Register explained in T.D. 8823 (July 2, 1999), the SRLY rules are designed to curb the use of newly acquired NOLs for offsetting income from other members, preventing loss trafficking. If an acquisition has no credible non-tax business rationale, the SRLY analysis may be moot because the transaction itself is at risk of challenge.
• § 269 as a statutory backstop. § 269 allows the IRS to disallow any deduction, credit, or other allowance when the principal purpose of an acquisition is evasion or avoidance of tax by securing a benefit that the acquiring person would not otherwise enjoy. This statutory provision operates alongside the judicial doctrines and the regulatory SRLY rules as an additional line of defense against loss trafficking.
• CAUTION. Even when SRLY rules technically permit a result, judicial doctrines may deny it. A practitioner should never rely solely on technical compliance with the SRLY regulations. Confirm that the acquisition has economic substance, a legitimate business purpose, and is not part of a pre-arranged plan to circumvent loss limitations. Document the business purpose contemporaneously.

Step 15. Documentation, Reporting, and Elections

• Form 1120 and consolidated schedules. A consolidated group must file Form 1120 with the appropriate consolidated schedules. The common parent files the return on behalf of the group. Schedule L reports balance sheet information on a consolidated basis. Schedule K reports other information including the group's NOL computation and carryover schedule. Each subsidiary's separate items must be properly compiled and attributed to support the SRLY cumulative register calculation.
• Election to file a consolidated return. Under § 1.1502-75(a), the common parent makes the election to file a consolidated return by filing a consolidated return for the group. The election is binding for all subsequent years unless terminated. Termination occurs if the group ceases to file consolidated returns, the affiliated group is terminated, or the common parent consents to a separate return under § 1.1502-75(c). Once made, the election to file consolidated returns generally cannot be revoked except in limited circumstances.
• Waiver of carryback period. Under § 172(b)(3), a corporation may elect to waive the entire carryback period for an NOL. The election is irrevocable and must be made by the due date (including extensions) of the return for the taxable year in which the NOL arises. For consolidated groups, the waiver election is made at the group level by the common parent. (§ 1.1502-21(b)) Making this election means the NOL can only be carried forward. It cannot later be carried back to a prior year.
• Farming loss carryback waiver. § 172(b)(1)(B)(iv) allows a separate election to waive the 2-year farming loss carryback. A farming loss that qualifies for the extended carryback period may be treated as a non-farming NOL if the taxpayer elects to waive the farming loss carryback. This election is also irrevocable and must be made by the return due date. Verify whether any group member's NOL is attributable to farming activities before making this determination.
• Records to maintain. The following records should be maintained in the permanent file for every consolidated group with SRLY members.
  • A schedule of all SRLY NOLs with year of origin, amount, expiration date (if applicable), and cumulative register balance. Update this schedule annually before filing.
  • Documentation of continuous affiliation for all SRLY subgroup tests, including stock ownership records proving the 60-month continuous affiliation requirement.
  • 60-month affiliation records for each member of every SRLY subgroup, including evidence of the former group relationship.
  • Fair market value and adjusted basis records for all built-in loss determinations under § 1.1502-15, including appraisals or valuation workpapers supporting the NUBIL computation.
  • A complete § 382 ownership change analysis and documentation, including testing date calculations, ownership shift schedules, and the § 382 limitation computation, for any SRLY member subject to the overlap rule.
  • A copy of all consolidated return elections, including the original election and any consent to terminate under § 1.1502-75(c).
  • Predecessor and successor transaction documents, including § 381(a) transfer agreements, carryover basis transaction records, and documentation supporting the application of any exception under § 1.1502-21(f)(2)(ii).
• Annual SRLY register reconciliation. Reconcile the cumulative SRLY register annually before filing the consolidated return. Track all additions, which consist of the SRLY member's contribution to consolidated taxable income for the year. Track all reductions, which include (1) SRLY losses absorbed against the member's own contribution, and (2) the member's losses absorbed by the group that reduce the register under § 1.1502-21(c)(1)(i)(B). Document the year-end register balance for each SRLY member and each SRLY subgroup. Cross-reference the register balance against the NOL carryover schedule to confirm that no SRLY loss deduction exceeds the available register.
• TRAP. Failure to document the business purpose for an acquisition contemporaneously can result in denial of loss utilization under judicial doctrines even when the SRLY rules technically allow it. Economic substance, business purpose, and substance-over-form challenges are fact-intensive. If the taxpayer does not create contemporaneous documentation of the non-tax reasons for an acquisition, the IRS and courts may infer that tax avoidance was the sole purpose. Board resolutions, investment committee memoranda, due diligence reports, and post-acquisition integration plans should be preserved.
• TRAP. The § 172(b)(3) waiver election is irrevocable. Once made for a consolidated return year, the group cannot later claim a carryback for that year's NOL. If the group discovers in a subsequent year that a carryback would have been valuable, no relief is available. Before making the waiver election, model both the carryback and carryforward scenarios for the group's entire NOL position, including SRLY and non-SRLY losses.