Sandra and John, who are unrelated, each own 50% of Alpha Corporation’s stock and 50% of Beta Corporation’s stock. For five years, Alpha has conducted manufacturing activities and sold machine parts primarily in the eastern United States. Alpha has reported $75,000 of operating profits in each of the last two years. Alpha’s annual operating profits are expected to grow to $150,000 during the next five years. Alpha has $100,000 of NOLs it is carrying forward. Alpha sells 25% of its product to Beta. Beta has been working to establish a market niche for reselling Alpha products in the southwestern United States. In the start-up phase of establishing the market, Beta incurred $200,000 of NOLs. Under the sales arrangement with Alpha, probably the best that Beta can hope to achieve in the short-run is reach a break-even point.
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What suggestions can you offer Sandra and John about the short-term possibility of using Alpha’s and Beta’s NOLs against the profits that Alpha expects to earn and about minimizing their overall tax liabilities if both businesses become profitable? Sandra has specifically asked about merging the two companies into a single entity so the losses of one entity can offset the profits of the other and delay the need to pay income taxes to the federal government. Sandra indicates that the two companies were created for business reasons and not tax avoidance reasons. The operating situation has changed and, according to Sandra, now may be the time to combine the entities into one. However, John is not sure that bringing the two businesses together is a good idea.