HBM Holdings Co. v. Commissioner, 167 T.C. No. 6 (July 27, 2026)

The United States Tax Court recently issued a reported decision in HBM Holdings Co. v. Commissioner, 167 T.C. No. 6 (2026), providing critical guidance on the intersection of Section 381 corporate liquidations, the "lonely parent" exception, and the Separate Return Limitation Year (SRLY) subgroup rules. For tax professionals advising corporate groups, this case underscores the rigidity of the consolidated return regulations and serves as a stark reminder that the Tax Court will not substitute "economic reality" or "common control" arguments for the explicit text of the Treasury Regulations.

This article provides a technical analysis of the facts in HBM Holdings, the taxpayer’s arguments for relief, the court's structural analysis of the consolidated return regulations, and the ultimate planning lessons for CPAs and tax practitioners.

Factual and Procedural Background

Petitioner HBM Holdings Company (HBM), a Missouri corporation, was incorporated in 2014 pursuant to a reorganization under I.R.C. § 368(a)(1)(F) (an "F reorganization"). HBM elected S corporation status as of its incorporation date under I.R.C. § 1362. As part of the F reorganization, Mississippi Lime Company (MLCO)—which was previously an S corporation—became HBM’s directly wholly owned subsidiary, and an election was made under I.R.C. § 1361(b)(3)(B)(ii) to treat MLCO as a Qualified Subchapter S Subsidiary (QSSS).

Historically, in 2012, MLCO had acquired Delavau Holdings, LLC (Delavau), a Delaware limited liability company taxed as a corporation. At the time of its acquisition, Delavau was treated as a loss corporation under I.R.C. § 382, carrying approximately $78 million in net operating loss (NOL) carryovers. As part of the 2014 F reorganization, MLCO distributed 100% of Delavau's stock to HBM, making Delavau a directly wholly owned subsidiary of the S corporation parent, HBM.

Effective July 1, 2018, HBM revoked its S corporation election pursuant to I.R.C. § 1362(d)(1)(A). Consequently, the S corporation status terminated, and the QSSS status of MLCO and three other subsidiaries—Aerofil Technologies, FLCO, Inc., and Schafer Industries, Inc.—also ceased, effective July 1, 2018. Concurrently, Delavau filed an entity classification election under Treas. Reg. § 301.7701-3(c) to be disregarded as separate from HBM, also effective July 1, 2018. Under the check-the-box regulations of Treas. Reg. § 301.7701-3(g)(1)(iii), this election resulted in a deemed liquidation of Delavau into HBM at the close of business on June 30, 2018.

The parties stipulated that this deemed liquidation fell under the auspices of I.R.C. §§ 332 and 381. Accordingly, under I.R.C. § 381, HBM succeeded to and was required to take into account Delavau’s NOL carryovers, which had grown to approximately $108 million at the time of liquidation. Importantly, the parties agreed that the deemed liquidation was not a "reverse acquisition" within the meaning of Treas. Reg. § 1.1502-1(f)(3).

Beginning July 1, 2018, HBM, as the common parent, formed a new consolidated group (the "HBM group") and filed a consolidated federal income tax return on Form 1120 for the short tax year running from July 1 through December 31, 2018. The initial members of the consolidated group were HBM and its newly eligible corporate subsidiaries: MLCO, Aerofil, FLCO, and Schafer (the "Founding Members"). Because Delavau was deemed liquidated prior to the formation of the consolidated group, it was never a member of the HBM group.

For the short tax year 2018 and all subsequent years through 2021, HBM on a separate entity basis generated no separate taxable income. However, the HBM group reported substantial aggregate consolidated taxable income before NOLs: $13,546,306 for the short tax year 2018, $46,827,513 for 2020, and $89,917,245 for 2021. On its consolidated returns, the group claimed consolidated net operating loss (CNOL) deductions of $13,546,306 (short year 2018), $14,970,260 (2020), and $1,092,709 (2021), completely offsetting HBM's separate lack of income by utilizing Delavau's preliquidation NOL carryovers.

The Commissioner of Internal Revenue (Respondent) disallowed the CNOL deductions in full for the short year 2018 and 2020, and disallowed $1,092,709 for 2021. The Commissioner asserted that the SRLY rules in the consolidated return regulations barred the application of Delavau's preliquidation NOL carryovers to offset the consolidated income of the other HBM group members. Both parties filed Cross-Motions for Partial Summary Judgment in the Tax Court to resolve this issue as a matter of law.

The Taxpayer's Request for Relief

HBM petitioned the Tax Court for partial summary judgment, requesting a ruling that the CNOL deductions were fully allowed. The taxpayer's primary argument centered on the application of the "lonely parent rule" under Treas. Reg. § 1.1502-1(f)(2)(i).

HBM contended that when Delavau was deemed liquidated into HBM, HBM "inherited" Delavau’s tax attributes, including its NOL carryovers, under I.R.C. § 381. Because HBM is the common parent of the consolidated group, HBM argued that the "lonely parent rule" exempts the separate return years (SRYs) that HBM inherited from Delavau from being classified as separate return limitation years (SRLYs). Under this theory, because HBM succeeded to the NOLs, the NOLs should be treated as though they were HBM’s own, thereby escaping SRLY limitations. HBM further argued that Delavau was not a "predecessor" of HBM under Treas. Reg. § 1.1502-1(f)(4) because HBM was not a member of a consolidated group at the time of the section 381 transaction, arguing that predecessor-successor status must be determined "as of the time of the relevant transaction".

Alternatively, HBM requested that if the court determined that the SRLY rules applied, HBM and the other Founding Members should be treated as an "SRLY subgroup" under Treas. Reg. § 1.1502-21(c)(2)(i). This would allow HBM to pool the group's income, applying the Delavau NOL carryovers to offset the taxable income generated by the other Founding Members. HBM argued that although the Founding Members were not technically part of an affiliated group before July 1, 2018, due to HBM’s S corporation status and the subsidiaries' QSSS status, they "were commonly controlled in a manner that would have constituted an affiliated group but for their disregarded status". HBM urged the court to look to "economic reality" and treat them as a subgroup because they were "under the common control and ownership of HBM" and entered the group together.

The Court's Analysis of the Law and Statutory Mergers

The Tax Court, in an opinion written by Judge Jenkins, rejected the taxpayer's arguments on all counts, granting partial summary judgment to the Commissioner. The court's analysis systematically deconstructed the interaction between I.R.C. § 381 and the consolidated return regulations under I.R.C. § 1502.

Separate Tracking of Inherited Net Operating Losses under Section 381

The court first addressed HBM’s foundational premise: that the inherited Delavau NOLs became indistinguishable from HBM's own. While I.R.C. § 381(a) dictates that an acquiring corporation succeeds to the NOL carryovers of a distributor corporation in a § 332 liquidation, the court noted that this succession is "subject to the conditions and limitations of section 381(b) and (c)".

The court pointed out that the regulations under section 381 explicitly require the separate tracking of distributor and acquiror attributes. Treas. Reg. § 1.381(c)(1)-1(a) and (e)(1) contemplate that distributor carryovers are integrated with those of the acquiring corporation, but "they illustrate consideration of the acquiring corporation's and distributor corporation's NOL carryovers separately in years after the first tax year following the distribution".

HBM relied heavily on Dover Corp. & Subsidiaries v. Commissioner, 122 T.C. 324 (2004), and Revenue Rulings 75-223 and 77-376 to argue that an acquiring parent is treated as having directly engaged in the business history of its liquidated subsidiary. However, Judge Jenkins distinguished these authorities, noting that they "all address the question of whether an acquiring corporation succeeds to the business history of its liquidated subsidiary... and not the question of whether the NOL carryovers of the combined entities are tracked separately". The court concluded that HBM's "broad reading that petitioner suggests would override clear statutory text in section 381(c)". Thus, the court ruled:

"This Court does not agree that the Delavau NOL carryovers became indistinguishable from HBM NOL carryovers."

Predecessor and Successor Status Under Treasury Regulation Section 1.1502-1(f)(4)

The court next turned to whether Delavau constituted a "predecessor" of HBM under the consolidated return definitions. Treas. Reg. § 1.1502-1(f)(4) provides:

"The term predecessor means a transferor or distributor of assets to a member (the successor) in a transaction . . . [t]o which section 381(a) applies."

Applying the plain meaning of this text, Delavau was a distributor of assets to HBM (a member of the consolidated group) in a transaction to which section 381(a) applies (the § 332 liquidation).

The court rejected HBM’s argument that predecessor-successor status must be determined "as of the time of the relevant transaction" (which would exclude HBM because it was not a "member" of a consolidated group when the liquidation occurred). Judge Jenkins noted that "the Court interprets regulations as it interprets statutes, starting with their plain meaning and looking at the text and design of the regulation as a whole". The court found that "there is no textual basis in Treasury Regulation § 1.1502-1(f)(4) for petitioner's position".

Furthermore, the court observed that other definitions in Treas. Reg. § 1.1502-1 "reflect that definitions are generally to be applied as of the tax year for which they are being taken into account," rather than at the historic transaction date. The court highlighted that under HBM’s temporal theory, a successor corporation would lose its "successor status" if it moved to a new consolidated group—a result directly contradicted by the examples in Treas. Reg. § 1.1502-21(c)(2)(viii)(A). The court also cited Treasury's explanation in T.D. 8823 that "In general, a predecessor is any transferor of assets in a section 381(a) transaction".

Accordingly, the court held:

"DRE [Delavau] is a predecessor to P [HBM] within the meaning of Treas. Reg. § 1.1502-1(f)(4), notwithstanding that the P consolidated group did not exist at the time of DRE’s deemed liquidation."

Exclusivity of the Lonely Parent Exception

Having established that Delavau was a predecessor of HBM, the court analyzed whether the "lonely parent rule" of Treas. Reg. § 1.1502-1(f)(2)(i) applied to exclude Delavau's SRYs from being treated as SRLYs.

Under the lonely parent rule, the term SRLY does not include a separate return year of "the corporation which is the common parent for the consolidated return year to which the tax attribute is to be carried". However, the court emphasized that "the wording and structure of the consolidated return group regulations make clear that the lonely parent rule does not apply to an SRY of a predecessor of the common parent".

To demonstrate this, Judge Jenkins performed a meticulous structural analysis of Treas. Reg. § 1.1502-1(f)(2):

The lonely parent rule is the first of three exceptions to the SRLY definition (Treas. Reg. § 1.1502-1(f)(2)(i)) and "conspicuously fails to mention predecessors".
In contrast, the second and third exceptions (Treas. Reg. § 1.1502-1(f)(2)(ii) and (iii)) explicitly exclude SRYs of "a member" or "a predecessor of any member" under certain daily membership conditions.
If a reference to a "member" (or the common parent) automatically encompassed its predecessor, these exceptions would overlap, making them entirely "unnecessary" and redundant.
Additionally, Treas. Reg. § 1.1502-1 does not contain a broad predecessor-successor attribution rule like that in Treas. Reg. § 1.1502-21(f)(1), which permits references to include predecessors "as the context requires".

Because Delavau was a predecessor and its SRYs constitute SRLYs, and because the lonely parent rule cannot be extended to predecessors of the common parent, the court concluded that Delavau's SRYs remained SRLYs. The court found support in the Sixth Circuit's decision in Wolter Construction Co. v. Commissioner, 634 F.2d 1029 (6th Cir. 1980), which held:

"Where a member of the group is the successor corporation in a 381 transaction, any net operating losses of the predecessor corporation are considered to have occurred in a SRLY if the predecessor was not a member of the group for each day of such year. The lonely parent rule does not apply in these situations, and the loss carryovers are subject to the SRLY restrictions, despite the fact that the common parent may be the successor corporation in the 381 transaction."

Rejecting the "Economic Reality" of S Corporation SRLY Subgroups

The court then addressed HBM's alternative argument that the Founding Members constituted an SRLY subgroup under Treas. Reg. § 1.1502-21(c)(2)(i).

By regulation, an SRLY subgroup for loss carryovers requires that the members joined the consolidated group at the same time and "were members of the same former group". The term "former group" is defined in the regulations as "another affiliated group".

The court applied the clear statutory and regulatory boundaries of S corporations and consolidated groups:

Prior to July 1, 2018, HBM was an S corporation.
Under I.R.C. § 1504(b)(6), an S corporation is an ineligible corporation and "cannot be a member of an affiliated group".
The other Founding Members were QSSSs and were "therefore disregarded as separate from HBM under section 1361(b)(3)(A)".
Consequently, because HBM was an S corporation and its subsidiaries were disregarded, "there was no former group".

Because there was no former affiliated group, the Founding Members could not constitute an SRLY subgroup under the plain text of the regulations.

The court was wholly unreceptive to HBM's argument that they should be treated as an SRLY subgroup based on "economic reality" and "common control". Citing its own precedent in Wolter Construction Co. v. Commissioner, 68 T.C. 39 (1977), the court stated:

"We are unwilling to read into the regulations an exception to the separate return limitation year solely on the belief that such an exception was inadvertently omitted. . . . [A]ny corporation seeking to deduct losses of another corporation from past years can do so only upon the authority of a specific provision."

Furthermore, the court clarified that HBM misunderstood the policy purpose of the SRLY subgroup rules. Their purpose "is not to aggregate income from 'related' entities in general; it is to preserve aggregation for continuously affiliated corporations". The subgroup rules are designed as a "narrow exception... to preserve 'single entity' treatment for members that move together from one affiliated group to another". Because there was no continuous affiliation within an affiliated group structure, treating the S corporation’s former disregarded subsidiaries as a subgroup would violate both the text and the policy of the consolidated return regulations.

Technical Application of the SRLY Limitation to the HBM Group

Under Treas. Reg. § 1.1502-21(c)(1)(i), a member’s SRLY losses can only be included in CNOL deductions to the extent of the consolidated taxable income of the group "attributable to that member".

As the successor to Delavau, HBM is the "member" whose separate income limits the use of the SRLY losses. Because HBM generated $0 of separate basis taxable income for the short tax year 2018, 2020, and 2021, the SRLY limitation for Delavau's $108 million in NOL carryovers was $0 for each of those years.

Because the Founding Members did not qualify as an SRLY subgroup, the HBM group could not aggregate the taxable income of MLCO, Aerofil, FLCO, or Schafer to absorb the Delavau NOLs. Thus, the SRLY NOL limitation remained $0, and the group's claimed CNOL deductions of $13,546,306, $14,970,260, and $1,092,709 were properly disallowed in full.

Critical Planning Takeaways for Tax Professionals

The Tax Court’s holding in HBM Holdings reinforces several foundational tenets of consolidated corporate tax planning:

First, the check-the-box regulations are not a magic wand. While converting a corporate subsidiary into a disregarded entity under Treas. Reg. § 301.7701-3 successfully triggers an I.R.C. § 332 liquidation and transfers attributes under I.R.C. § 381, it does not cleanse those attributes of their historical character. Inherited losses remain subject to separate tracking and the SRLY rules.
Second, S corporation history is a barrier to consolidated SRLY subgroups. S corporations and their QSSSs enjoy "single-entity" treatment for many income tax purposes, but they do not constitute an "affiliated group" under I.R.C. § 1504. Practitioners must realize that transitioning an S corporation group into a C corporation consolidated group will erase any historical subgroup status for SRLY purposes. Commonly controlled entities entering a consolidated group from an S corporation structure will be treated as separate, isolated members, each subject to its own individual SRLY limitation.
Third, the Tax Court demands strict textual compliance. Arguments based on "economic reality" or "economic substance" will not override the literal, interlocking text of the consolidated return regulations. When structuring corporate acquisitions and reorganizations, CPAs and EAs must model the SRLY limitations on an individual member-by-member basis unless an explicit, regulatory exception applies.

Prepared with assistance from NotebookLM.