What Corporations Are Required to File a Consolidated Tax Return?

Even small businesses may find it convenient to form subsidiary companies or may pick one up by acquisition. The Internal Revenue Service doesn't require corporations to file consolidated tax returns with their subsidiaries, but it does allow them to do so. Before a corporation can file a consolidated return, it must satisfy certain stock ownership and voting requirements. But even if your corporation satisfies the eligibility requirements, you may want to weigh the advantages against the disadvantages of filing a consolidated return with the other corporations in which your business has ownership interests.

Only corporations that are members of an affiliated group have the option of filing a consolidated return. An affiliated group exists when one corporation -- referred to as the parent -- holds stock that satisfies the voting and value requirements in at least one other corporation. This means that the parent must hold at least 80 percent of value of the corporation's outstanding stock and must possess at least 80 percent of the shares that are eligible to vote. Moreover, additional corporations directly owned by a subsidiary -- which means the parent company doesn't hold the additional corporations' stock -- can also be members of the affiliated group. For example, if your corporation owns 100 percent of a subsidiary that holds 100 percent of the stock in a third corporation, all three entities are members of the affiliated group and may file a single consolidated tax return.

When the parent company files a consolidated Form 1120 -- the federal corporate tax return -- the financial activity of all affiliated group members are essentially combined to arrive at a single taxable income figure. The principal advantage of filing a consolidated return is that the losses of one corporation can offset the profit of another -- which means less income tax is owed than if separate returns are filed for each member corporation. Other benefits include elimination of intercompany dividends from the corporation's income and, in some cases, the ability to take certain deductions and credits that the corporations may not qualify for on their own. The main disadvantage, however, is that once you file a consolidated return, all future returns for all members must be consolidated.

Each subsidiary corporation must authorize and consent to its inclusion in the consolidated return. This consent requires an officer of each subsidiary to furnish the parent company with Form 1122. The parent corporation -- the affiliated group member that's responsible for filing the return -- must attach a copy of each subsidiary's Form 1122 to its initial consolidated return. In future tax years, Form 1122 is only required for new affiliated group member corporations that are included on the consolidated return for the first time.

Certain corporations and other business entities are ineligible to be included on a consolidated return. This includes S corporations, tax-exempt corporations organized under Section 501 of the Internal Revenue Code, such as charities, insurance companies, corporate entities formed outside of the United States or in a U.S. possession, regulated investment trusts and real estate investment trusts, or REITs. Non-corporate entities, such as partnerships and limited liability companies, can never be included on a consolidated corporate return.