What is a Loss Disallowance Rule?

The Loss disallowance rule is a rule that prohibits a corporation or a consolidated group from filing a single tax return on all its subsidiaries just for tax benefits. In the United States, corporations file a single tax return on all their subsidiaries and thereby claim a tax deduction on losses accrued on the stock of the subsidiaries. The loss disallowance rule was created by the Internal revenue Service (IRS) to disallow such filing.

How Does a Loss Disallowance Rule Work?

The loss disallowance rule was established in the 1990s, this rule prevents losses incurred by a subsidiary being claimed as a tax deduction by a consolidated group. Through this rule, corporations pay due taxes on their capital gains and are disallowed from claiming tax deductions twice on the same loss. In 1995, the IRS changed the loss disallowance rule and created a new version. The new version removed certain provisions that were accommodated by the loss disallowance rule and added new rules. 

Rite Aid Corporation v. United States 

The case between Rite Aid Corp v. the United States is important in the history of the loss disallowance rule. Rite Aid is a bookstore corporation that has a chain of subsidiary companies in the 1980s. In 1988, Rite Aid also added the Penn Encore to its chain of companies and include the company when filing its tax returns. The loss of Penn Encore was also reported by Rite Aid in order to claim tax deductions due to the loss. As at this time, Rite Aid successfully claimed the deduction before the loss disallowance rule was created. This rule prohibits a corporation from claiming benefits by duplicating the loss factor of its subsidiary.