United States: Tax Court Holds NOL Attribute Reduction Must Be Treated On A Consolidated Basis

The Tax Court ruled in Marvel Entertainment LLC et al. v. Commissioner (145 T.C. No. 2) that the Marvel Entertainment consolidated group must reduce its entire consolidated net operating loss (CNOL) by the total cancellation of indebtedness (COD) income that four group members excluded from gross income. Marvel had taken the "separate entity" approach in applying the excluded COD income to reduce its CNOL on facts that predated the promulgation of consolidated COD income regulations under Treas. Reg. Sec. 1.1502-28T that now require the single-entity approach.

The case involves CNOLs stemming from the 1998 tax year that Marvel carried forward to its 2003 and 2004 tax years. Marvel subsequently received notices of deficiency for the 2003 and 2004 tax years as the IRS challenged Marvel's attribute reduction method in light of the excluded COD income. Marvel, under Section 108(a)(1)(a), had excluded the COD income from gross income under the bankruptcy exception and correspondingly reduced its attributes as required under Section 108(b)(2)(A). Marvel allocated the CNOL to each member and then applied each member's separate COD to reduce the allocated NOL for only that member of the group that incurred the excluded COI income. This "separate entity" approach effectively preserved a larger amount of Marvel's CNOL than would have been calculated if the total group's COD been applied to the CNOL (i.e., by using the "single entity" approach).

The Tax Court, citing the Supreme Court's 2001 decision in United Dominion Industries Inc. v. United States (532 U.S. 822) agreed with the government that the single-entity approach should have been used, whereby the total amount of excluded COD income should have been applied against the entire group's CNOL in calculating the amount attribute reduction. In United Dominion, the Supreme Court ruled that the consolidated return regulations provide for only one definition of NOL and that is on a consolidated basis.

Ultimately, the Tax Court rejected Marvel's arguments that the plain language of Section 108 proved that Congress intended that consolidated groups use a separate-entity approach.

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