Reed Smith Client Alerts

The Tax Court of New Jersey’s decision in MCI Communication Services, Inc. v. Director, Division of Taxation,1 which involved the coordination of federal cancellation of indebtedness and consolidated return rules with the corporation business tax, has been affirmed by the New Jersey appellate court.

Authors: David J. Gutowski Kyle O. Sollie Matthew L. Setzer

Background

The taxpayer at issue (“Taxpayer”) was a corporate subsidiary of MCI, Inc. (“MCI”). For federal income tax purposes, Taxpayer filed as part of the MCI consolidated group. As a result of Chapter 11 bankruptcy proceedings, MCI had cancellation of indebtedness income (“CODI”) of $25 billion. Although MCI was able to exclude that CODI from its federal consolidated income, it was required under I.R.C. § 108(b) to reduce its tax attributes by the same amount. Of the $25 billion of CODI, only $71 million was related to debt owed directly by Taxpayer. But because its upper-tier affiliates’ tax attributes were insufficient to absorb the CODI, the federal consolidated return rules required Taxpayer to reduce its tax attributes by $3.6 billion. For the 2005 tax year, this resulted in Taxpayer having $271 million less depreciation deductions for consolidated federal income tax purposes.