“I’m a Loser, Baby”: U.S. Tax Court Shuts Down NOL Utilization Strategy

The Facts of the HBM Holdings Case
The story begins in 2012. In that year, Mississippi Lime Co. (MLCO), an S corporation, acquired Delavau Holdings, LLC (LossCo), a limited liability company taxable as a C corporation. LossCo had $78 million in NOL carryovers at the time of the acquisition. These tax attributes caused LossCo to be treated as a loss corporation within the meaning of Code § 382(k)(1). Although the opinion is silent on the point, it’s likely that these NOL carryovers were limited by Code § 382(a) following the acquisition by MLCO.

In 2014, the shareholders of MLCO formed HBM Holdings (HBM). HBM elected to be treated as an S corporation. As a part of a tax-free reorganization, HBM acquired MLCO. MLCO elected to be treated as a qualified subchapter S subsidiary (within the meaning of Code § 1361(b)(3)(B)) of HBM. Immediately thereafter, MLCO distributed the stock of LossCo to HBM. HBM had three other operating subsidiaries as well. Each of these subsidiaries was treated as a corporation for federal income tax purposes.

On July 1, 2018, HBM revoked its election to be treated as an S corporation. As of the date of the revocation of the S corporation election, LossCo filed an election to be treated as a disregarded entity.^[4]This election caused LossCo to undergo a deemed liquidation.^[5]The deemed liquidation resulted in HBM succeeding to the NOL carryovers held by LossCo.^[6]As stated above, by this date, LossCo’s NOL carryovers had increased to $108 million.

Beginning immediately after HBM’s revocation of its S corporation election, it elected to file a consolidated federal income tax return with its three remaining operating subsidiaries. HBM itself had no taxable income or loss. All of the group’s income was generated by the three operating subsidiaries. This affiliated group claimed NOL deductions (referred to as consolidated net operating losses or CNOLs) held by HBM (as the successor to LossCo) in each of its 2018 through 2021 taxable years. The Internal Revenue Service (IRS) challenged the HBM group’s ability to use the NOL carryover deductions under the separate return limitation year (SRLY) rules.

The General Rules for Determining Consolidated Group Taxable Income or Loss
Under the general rules for corporations included in a consolidated return, the losses and NOL carryovers incurred by one member of the affiliated group can be used to offset the income earned by another member of the affiliated group included in the return.^[7]Special rules are provided, however, for NOL carryovers incurred by a member of the group prior to its inclusion in the affiliated group. NOL carryovers incurred prior to the time that the member was part of the affiliated group are said to have been incurred in a separate return year (SRY). The SRLY rules prevent a corporation with NOL carryovers from its pre-inclusion taxable years (SRYs) from importing those losses into the consolidated return.

The SRLY Limitation
A SRLY exists if a member of an affiliated group of corporations filing a consolidated federal income tax return, or a predecessor of a member (i) has filed a stand-alone federal income tax return for a prior taxable year or (ii) was part of another group that filed a consolidated return in a prior taxable year.

^[8]A member is considered to contain a predecessor if it acquires a corporation from outside of the group in a transaction to which Code § 381(a) applies.^[9]When an affiliated group filing a consolidated return with multiple members having NOL carryovers is acquired by another affiliated group, the acquired group constitutes a “SRLY subgroup.”^[10]

In general, SRLY NOL carryovers incurred by a member may not be applied to reduce the income or gains of other members included in the consolidated return.^[11]Instead, the cumulative separate stand-alone net income of the member with a SRLY NOL carryover is calculated, and the NOL carryover may be applied in each year to reduce that member’s stand-alone cumulative net income. This computation is commonly referred to as the “cumulative register rule.”^[12]The cumulative register tracks the member’s cumulative stand-alone net income and SRLY NOL usage. The SRLY NOL can be used against a member’s stand-alone tax liability to the extent that the cumulative register is positive.^[13]When a SRLY subgroup exists, these computations are made for the entire subgroup, not the individual members thereof.^[14]

When a member with a SRLY NOL is liquidated into its parent corporation in a transaction described in Code § 332 (relating to liquidations of subsidiaries into parent corporations holding 80% or more of the stock of the liquidated subsidiary), the liquidated corporation is treated as a “predecessor.” In this case, the IRS has taken the position that the cumulative register consists of the positive sum of (x) the results of all years of the liquidated corporation during which it was included in the consolidated return and (y) the results of the distributee corporation for all periods following the liquidation of the subsidiary.^[15]In CCA 200224042, the IRS refused to permit the cumulative register to include the results of the parent for periods prior to the liquidation of the subsidiary.^[16]

The SRLY limitation does not apply to NOL carryovers held by the common parent corporation of the affiliated group filing a consolidated return. This exception is referred to as the “lonely parent rule.”^[17]As the court observed, “’the corporation which is the common parent for the consolidated return year to which the tax attribute is to be carried’ is not an SRLY” loss.^[18]The taxpayer asserted that the lonely parent rule prevailed over the application of the predecessor rule when the loss company is liquidated into the common parent corporation. This position, if successful, would have allowed the NOL carryovers, now possessed by HBM, to offset the income earned by HBM’s three operating subsidiaries. Alternatively, the taxpayer argued that the three operating subsidiaries were part of a SRLY subgroup with LossCo.

The Court’s Reasoning in Denying the Consolidated Group from Using the LossCo NOL Carryovers
The only path for the taxpayer to use the LossCo NOL carryovers was to convince the court to apply the lonely parent rule to the losses. The court began its inquiry by looking at the operation of the attribute carryover rules contained in Code § 381(a). The taxpayer then argued that since the liquidation of LossCo occurred immediately prior to the formation of the affiliated group of which HBM was the common parent, that LossCo should not be viewed as a predecessor transferring its SRLY NOL carryover to HBM. The court, however, found it significant that the applicable Treasury regulations refer to pre-combination losses of the liquidated subsidiary separately from the pre-combination losses of the distributee (parent) corporation.^[19]The court refused to treat LossCo and HBM as a single entity for SRLY purposes because “Treasury Regulation § 1.1502-1(f)(4) does not limit successors to corporations that were members at the time of a relevant transaction, it requires only that a corporation be a member for the relevant consolidated return year.”

Since the taxpayer could not convince the court not to treat LossCo as a predecessor, it urged the court to hold that the lonely parent rule overrode the predecessor rule. The court held, however, “the lonely parent rule does not apply to SRY of a predecessor of the common parent.” The court came to this conclusion by relying on the fact that the regulation did not explicitly contain a rule that treated the predecessor SRY as a taxable year of the common parent. It noted that another regulation (Treasury Regulation § 1.1502-21(f)(1)) explicitly did so. Since Treasury knew how to make this explicit inclusion, its failure to do so in the lonely parent rule was evidence that a predecessor SRY was not treated as eligible for the lonely parent rule.

The court quickly dispatched the taxpayer’s assertion that LossCo and the three operating subsidiaries constituted a SRLY subgroup. A SRLY subgroup exists when the corporations had previously been part of another affiliated group filing a consolidated federal income tax return.^[20]Since LossCo and the three operating subsidiaries had not been included in a consolidated return, they could not constitute a SRLY subgroup.

Could the Taxpayer Have Avoided This Conundrum?
Monday morning quarterbacking is easy, and there may have been valid reasons why the taxpayer chose the tax structure that it employed in the HBM case. If, however, the taxpayer had filed check-the-box elections to treat the three operating subsidiaries as disregarded entities owned by HBM, then the income earned by such subsidiaries would have constituted income earned by the common parent. Such attributed income would have increased the balance in the cumulative register of the common parent. This increase would have allowed HBM to use the NOL carryovers of LossCo.

It’s hard not to perceive that the court was overly formalistic in its application of the lonely parent rule. Since the simple expedient of the check-the-box election for the subsidiaries would have allowed the group to use the LossCo NOL carryovers, the court could easily have concluded that the group should not have been denied access to LossCo NOL carryovers if the subsidiaries retained their tax existence within the affiliated group.

Mark Leeds and Nora Burke regularly work with loss companies on strategies to preserve and utilize tax attributes. Mark and Nora are always available to answer questions regarding these issues.

^{[1] 167 T.C. No. 6 (July 27, 2026)}

^{[2] All Code § references are to the Internal Revenue Code of 1986, as amended.}

^{[3] Loser is included on the album Mellow Gold (Bong Load * DGC), Beck and Carl Stephenson (1993).}

^{[4] See Treasury Regulation § 301.7701-3(c)}

^{[5] Treas. Reg. § 301.7701-3(g)(1)(iii).}

^{[6] Code §§ 332, 381.}

^{[7] Treas. Reg. § 1.1502-1(h), 1.1502-21(a)(1).}

^{[8] Treas. Reg. § 1.1502-1(f).}

^{[9] Treas. Reg. § 1.1502-1(f)(4)(i).}

^{[10] Treas. Reg. § 1.1502-21(c)(2).}

^{[11] See Treas. Reg. § 1.1502-21(c)(1)(i).}

^{[12] Id.; see CCA 200924042 (June 12, 2009).}

^{[13] See Treas. Reg. § 1.1502-21(c)(1)(iii)(Ex. 3).}

^{[14] Treas. Reg. § 1.1502-21(c)(2).}

^{[15] CCA 200924042. If the cumulative register is a negative number, the surviving corporation cannot access the SRLY NOLs. Id.}

^{[16] See also PLR 8551017 (Sep. 20, 1985). This conclusion was bases upon the IRS’s view of how the rules should work, rather than an interpretation of any regulation or other authority.}

^{[17] Treas. Reg. § 1.1502-1(f)(2)(i).}

^{[18] Citing Treas. Reg. § 1.1502-1(f)(2)(i).}

^{[19] Treas. Reg. § 1.381(c)(1)-1(a).}

^{[20] Treas. Reg. § 1.1502-21(c)(2).}