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What are the ramifications to DISC status if there is a loss?  

Are there any required disclosures, elections or adjustments required on the tax return?

I found the IRS audit guide, and I'm uncertain how to decipher this:

"Like FSC, the DISC also has a no loss rule when applying the available pricing methods. However, the mechanical application of the DISC no-loss rules is different than the FSC no loss rules and can lead to a different result."

Under intercompany pricing rules:

"No Loss Rule [54] - if either the 4% QER method or the 50% CTI method is used it is subject to a “no loss” rule.  This rule provides that the neither method may be applied if it would cause a loss to the R-S. (related supplier)

1. A loss is defined as when the taxable income of the DISC (Part I - Sections B & C of Schedule P) would exceed the CTI of the R-S and the DISC (Part I Section A of Schedule P).

   1.  The obvious starting point then would be to compute the CTI before computing the DISC taxable income. This is consistent with the format of the Form 1120 IC DISC - Schedule P.

2. If there is no CTI of the R-S and the DISC (meaning there is already a loss before the transfer price or commission was determined) then the transfer price or commission will not be deemed to cause a loss to the  R-S if it allows the DISC to recover an amount not in excess of its costs. 

3. Special rule for 4% QER to sales – This method will not be considered to cause a loss for the R-S if the ratio of (DISC taxable income / DISC gross receipts) is not greater than the ratio of (R-S &  DISC taxable income / R-S & DISC gross receipts).

4. See the example in Treas. Reg. § 1.994-1(e)(1)(ii)."

There is additional information regarding Marginal Costing Pricing Rules of IRC Section 994b which also has no loss rules.  

7. Were there losses?

TD 8805 issued, January 11, 1999, contains final and temporary regulation regarding the “Allocation of Loss With Respect to Stock and Other Personal Property; Application of Section 904 to Income Subject to Separate Limitations”. 

Generally, the effective date of the regulations is January 11, 1999.  However, the taxpayer may elect to apply these rules to tax years beginning on or after January 1, 1987.  If a taxpayer allocates a loss, you need to know the applicable regulation(s).  It is suggested you start with the Supplemental Information contained in TD 8805, to find the answer.

Treas. Reg. § 1.861-8(e)(8) provides that a NOL deduction allowed under § 172 shall be allocated and apportioned in the same manner as the deductions giving rise to the NOL deduction. 

Thank you in advance.  

IC-DISC Audit Guide

Irs		remove preview
IC-DISC Audit Guide LB&I-04-0212-003 A GENERAL OVERVIEW OF THE DISC THE DISC LAW AND MAJOR CONCEPTS TAXATION OF A DISC - IRC § 991 REGULATION § 1.991-1(b)(2) PLACES RESTRICTIONS ON THE METHOD OF ACCOUNTING THE DISC MAY CHOOSE WHEN DEALING WITH A TRANSACTION BETWEEN THE DISC AND OTHER MEMBERS OF THE SAME CONTROLLED GROUP TO WHICH THE DISC BELONGS DISC DEFINED - IRC § 992 QUALIFIED EXPORT RECEIPTS - IRC § 993(a) & (f) AND TREAS. View this on Irs >

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Laura Sabbagh
LAURA SABBAGH, CPA PC
Wantagh NY

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Sometime between 1975 and 1978, my employer took the staff and an IRS agent out to lunch.  He said that he was once assigned to phone duty.  A caller started asking him some basic corporate tax questions.  The caller then asked if the answers would be different if it was a DISC corporation.  The agent being unfamiliar with a DISC said to the caller "so what if you sell records" and hung up the phone.

Not pertinent to the question at hand but I think we can all use a chuckle in tax season

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Alan Aron
ALAN ARON, CPA PC
MELVILLE NY

Original Message:
Sent: 02-08-2016 15:46
From: Laura Sabbagh
Subject: Treatment of 1120 DISC losses

What are the ramifications to DISC status if there is a loss?  

Are there any required disclosures, elections or adjustments required on the tax return?

I found the IRS audit guide, and I'm uncertain how to decipher this:

"Like FSC, the DISC also has a no loss rule when applying the available pricing methods. However, the mechanical application of the DISC no-loss rules is different than the FSC no loss rules and can lead to a different result."

Under intercompany pricing rules:

"No Loss Rule [54] - if either the 4% QER method or the 50% CTI method is used it is subject to a “no loss” rule.  This rule provides that the neither method may be applied if it would cause a loss to the R-S. (related supplier)

1. 
   

   A loss is defined as when the taxable income of the DISC (Part I - Sections B & C of Schedule P) would exceed the CTI of the R-S and the DISC (Part I Section A of Schedule P).

   
   
   
   
   1. 
      

       The obvious starting point then would be to compute the CTI before computing the DISC taxable income. This is consistent with the format of the Form 1120 IC DISC - Schedule P.

      
      
   
   
   
   


2. 
   

   If there is no CTI of the R-S and the DISC (meaning there is already a loss before the transfer price or commission was determined) then the transfer price or commission will not be deemed to cause a loss to the  R-S if it allows the DISC to recover an amount not in excess of its costs. 

   
   


3. 
   

   Special rule for 4% QER to sales – This method will not be considered to cause a loss for the R-S if the ratio of (DISC taxable income / DISC gross receipts) is not greater than the ratio of (R-S &  DISC taxable income / R-S & DISC gross receipts).

   
   


4. 
   

   See the example in Treas. Reg. § 1.994-1(e)(1)(ii)."

   
   

There is additional information regarding Marginal Costing Pricing Rules of IRC Section 994b which also has no loss rules.  

7. Were there losses?

TD 8805 issued, January 11, 1999, contains final and temporary regulation regarding the “Allocation of Loss With Respect to Stock and Other Personal Property; Application of Section 904 to Income Subject to Separate Limitations”. 

Generally, the effective date of the regulations is January 11, 1999.  However, the taxpayer may elect to apply these rules to tax years beginning on or after January 1, 1987.  If a taxpayer allocates a loss, you need to know the applicable regulation(s).  It is suggested you start with the Supplemental Information contained in TD 8805, to find the answer.

Treas. Reg. § 1.861-8(e)(8) provides that a NOL deduction allowed under § 172 shall be allocated and apportioned in the same manner as the deductions giving rise to the NOL deduction. 

Thank you in advance.  

IC-DISC Audit Guide

Irs		remove preview
IC-DISC Audit Guide LB&I-04-0212-003 A GENERAL OVERVIEW OF THE DISC THE DISC LAW AND MAJOR CONCEPTS TAXATION OF A DISC - IRC § 991 REGULATION § 1.991-1(b)(2) PLACES RESTRICTIONS ON THE METHOD OF ACCOUNTING THE DISC MAY CHOOSE WHEN DEALING WITH A TRANSACTION BETWEEN THE DISC AND OTHER MEMBERS OF THE SAME CONTROLLED GROUP TO WHICH THE DISC BELONGS DISC DEFINED - IRC § 992 QUALIFIED EXPORT RECEIPTS - IRC § 993(a) & (f) AND TREAS. View this on Irs >

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Laura Sabbagh
LAURA SABBAGH, CPA PC
Wantagh NY

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