## Facts

- Covil Insulation Co., Inc. was the common parent of an affiliated group filing consolidated federal income tax returns.
- In 1965, Covil acquired all outstanding stock of J.L. Wynn & Co. for $5 and renamed it Imesco, Inc.
- Covil capitalized $45,000 of Imesco’s indebtedness, increasing Covil’s basis in the Imesco stock.
- In consolidated returns, Imesco’s operating losses were used to offset income of other affiliates and cumulatively exceeded Covil’s basis in the Imesco stock.
- Under consolidated return regulations, losses exceeding stock basis created an “excess loss account” (ELA) with respect to Imesco stock; by 1968, Covil’s ELA exceeded $118,000.
- Covil completely liquidated Imesco in 1968, an event that the regulations treated as triggering recognition of the ELA.
- Covil did not include the ELA amount in income for the liquidation year; the Commissioner determined deficiencies for 1965 and 1969 based in part on requiring inclusion of the full ELA as taxable income.

## Issues

1. Whether the consolidated return regulations under I.R.C. § 1502 validly required Covil to recognize as taxable income the amount of its excess loss account upon liquidation of its subsidiary.
2. Whether the Commissioner properly applied those regulations to require inclusion of Covil’s full excess loss account in income for the year of liquidation.

## Decision

- The Tax Court sustained the Commissioner’s determination requiring inclusion of the excess loss account in income upon liquidation.
- The court held the excess loss account regulations were a valid exercise of regulatory authority under I.R.C. § 1502.
- Covil was required to recognize as ordinary income the full amount of the excess loss account in its subsidiary’s stock in the liquidation year.

## Legal Principles

- Filing consolidated returns is elective and subject to regulatory conditions prescribed under I.R.C. § 1502 to clearly reflect income and prevent avoidance.
- Treasury’s authority under § 1502 is broad, and consolidated return regulations will be upheld if reasonably directed to accurate determination of group tax liability and anti-avoidance objectives.
- When a consolidated group uses a subsidiary’s losses beyond the parent’s stock basis, an excess loss account functions as negative basis reflecting prior tax benefits.
- Consolidated return regulations may require recognition of the excess loss account as income upon specified triggering events, including liquidation, to prevent duplicative tax benefits from prior loss utilization and later nonrecognition of gain.

## Conclusion

The Tax Court upheld the consolidated return excess loss account regime and required Covil to include in income the amount of its excess loss account upon liquidating its subsidiary, treating the inclusion as a permissible recapture of prior consolidated loss benefits under I.R.C. § 1502.


Covil Insulation Co. v. Commissioner, 65 T.C. 364 (1975)