HBM Holdings Co. v. Commissioner: Tax Court Denies $29.6M in NOL Carryovers Due to SRLY Rules

The $29.6 Million Mistake: HBM Holdings Loses Bid to Claim Delavau’s NOL Carryovers

The U.S. Tax Court on Monday dealt a $29.6 million blow to HBM Holdings Company, denying its motion for partial summary judgment and affirming the IRS’s position that the company could not use net operating loss carryovers from Delavau’s deemed liquidation to offset consolidated income. In a precedential opinion filed in HBM Holdings Company v. Commissioner, 167 T.C. No. 6 (July 27, 2026), Judge Lauber held that the loss carryovers were subject to strict Separate Return Limitation Year (SRLY) rules under Treas. Reg. § 1.1502-21, rejecting HBM’s argument that the “lonely parent rule” under Treas. Reg. § 1.1502-1(f)(2)(i) allowed the losses to bypass those restrictions. The decision underscores the Tax Court’s willingness to enforce consolidated return limitations with surgical precision, even when the economic consequences are severe.

At issue was whether Delavau’s $29.6 million in net operating loss carryovers—arising from a deemed liquidation under I.R.C. § 332 in 2018—could be used by HBM’s consolidated group to offset income in tax years 2018 through 2021. The IRS argued that the losses were barred by the SRLY rules, which prevent consolidated groups from using losses generated by a member outside the group during its separate return years. HBM countered that because it had never been part of a consolidated group when Delavau incurred the losses, the “lonely parent rule” should exempt the carryovers from SRLY restrictions. The court flatly rejected that theory, concluding that the SRLY rules applied regardless of HBM’s prior filing status.

The ruling marks a rare instance where the Tax Court has explicitly rebuffed a taxpayer’s attempt to invoke the lonely parent rule to escape SRLY limitations, signaling a broader judicial trend toward strict interpretation of consolidated return provisions. Tax practitioners warn that the decision could chill similar NOL utilization strategies in post-acquisition planning, particularly where deemed liquidations under § 332 are involved.

A Chronology of Missed Opportunities: How HBM Holdings’ Reorganization Backfired

The seeds of HBM Holdings’ $29.6 million tax deficiency were sown in 2012, when Mississippi Lime Co. (MLCO)—a Missouri S corporation—acquired Delavau Holdings, LLC, a Delaware LLC taxed as a corporation. At the time of acquisition, Delavau carried forward approximately $78 million in net operating loss (NOL) carryovers, a tax asset that would later become the centerpiece of a bitter dispute with the IRS. The acquisition was structured as a taxable stock purchase, triggering an ownership change under § 382, which capped Delavau’s future NOL usage at roughly $29.6 million annually based on its value and the applicable long-term tax-exempt rate.

The first major misstep occurred in 2014, when HBM Holdings was incorporated as part of a § 368(a)(1)(F) reorganization—a so-called "F reorganization" designed to create a new corporate structure while preserving tax attributes. HBM was immediately elected as an S corporation under § 1362, a status that would later prove disastrous. As part of the reorganization, MLCO became a wholly owned subsidiary of HBM, and an election was made under § 1361(b)(3)(B)(ii) to treat MLCO as a qualified subchapter S subsidiary (QSSS). Crucially, Delavau’s stock was distributed to HBM, placing it directly under HBM’s ownership structure. At this stage, Delavau remained a separate taxable entity, but its NOL carryovers were now under HBM’s control—a fact that would later collide with consolidated return rules.

The second critical error unfolded in 2018, when HBM revoked its S corporation election under § 1362(d)(1)(A), effective July 1, 2018. This revocation triggered a cascade of tax consequences. First, the QSSS status of MLCO and three other subsidiaries (Aerofil Technologies, FLCO, Inc., and Schafer Industries, Inc.) automatically terminated. Second, Delavau filed an entity classification election under Treas. Reg. § 301.7701-3(c) to be disregarded as separate from HBM, effective July 1, 2018. Under Treas. Reg. § 301.7701-3(g)(1)(iii), this election caused Delavau to be deemed to liquidate into HBM at the close of business on June 30, 2018. The parties agreed that § 332 (liquidation of a subsidiary into a parent) and § 381 (transfer of tax attributes in corporate acquisitions) applied to this deemed liquidation.

The deemed liquidation under § 332 meant HBM inherited Delavau’s tax attributes, including its $108 million in NOL carryovers as of the liquidation date—a figure that had grown from the original $78 million due to intervening years of losses. Under § 381, HBM succeeded to Delavau’s NOLs, which it sought to use to offset the consolidated group’s taxable income in subsequent years. However, the reorganization had never included Delavau as a member of the HBM consolidated group. The group’s initial members—HBM, MLCO, Aerofil, FLCO, and Schafer—operated separately from Delavau, which remained a disregarded entity until its deemed liquidation.

By the time HBM filed its first consolidated return for the short tax year ending December 31, 2018, the stage was set for disaster. The HBM group claimed consolidated net operating loss (CNOL) deductions of $13,546,306 for 2018, $14,970,260 for 2020, and either $1,162,348 or $1,092,709 for 2021, all attributable to Delavau’s pre-liquidation NOL carryovers. The group reported aggregate taxable income of $13,546,306 for 2018, $46,827,513 for 2020, and $89,917,245 for 2021 before applying the CNOL deductions. Yet despite these figures, HBM had no separate taxable income in any of these years. The CNOL deductions were entirely dependent on Delavau’s NOLs, which the IRS would later argue were barred by the separate return limitation year (SRLY) rules under Treas. Reg. § 1.1502-21.

The reorganization’s fatal flaw was its failure to integrate Delavau into the HBM consolidated group before its deemed liquidation. Had HBM structured the transaction differently—perhaps by ensuring Delavau was a direct member of the group prior to the liquidation—the SRLY limitations might not have applied. Instead, the deemed liquidation under § 332 and the subsequent disregard election under Treas. Reg. § 301.7701-3 created a tax structure where Delavau’s NOLs were trapped in a legal limbo, neither fully part of the HBM group nor free from SRLY restrictions. The result was a $29.6 million tax deficiency that HBM would spend years—and millions in legal fees—trying to overturn.

The Battle Lines: HBM Holdings vs. the IRS on NOL Carryovers

The stakes could not have been higher for HBM Holdings. At issue was whether the company could apply Delavau’s $29.6 million in net operating loss (NOL) carryovers to offset the consolidated taxable income of the HBM group—a move that would erase the deficiency the IRS had assessed. The case hinged on two narrow but consequential legal theories: first, whether the "lonely parent rule" exempted Delavau’s NOLs from the Section 1502 SRLY restrictions, and second, whether HBM and its Founding Members constituted an SRLY subgroup under Treasury Regulation § 1.1502-21(c)(2)(i). The IRS, armed with a strict reading of the consolidated return rules, argued that Delavau’s NOLs were forever trapped by the SRLY limitations. HBM, in contrast, contended that its status as the common parent of the group—and the Founding Members’ shared SRLY history—provided a clear path to unlock those losses.

HBM’s position rested on two interlocking arguments. First, it invoked the lonely parent rule, codified in Treasury Regulation § 1.1502-1(f)(2)(i), which exempts a parent corporation’s pre-group NOLs from SRLY limitations if the parent was never part of a consolidated group before joining its current one. HBM argued that Delavau’s NOLs were not subject to SRLY because Delavau was deemed to have liquidated into HBM under Section 332, making HBM the successor in interest to Delavau’s tax attributes. Since HBM had never been part of a consolidated group prior to acquiring Delavau, the company claimed the lonely parent rule applied, shielding Delavau’s NOLs from SRLY restrictions. Second, HBM asserted that it and the Founding Members formed an SRLY subgroup under Treasury Regulation § 1.1502-21(c)(2)(i), which would allow the group to apply Delavau’s NOLs against the subgroup’s income. The Founding Members, HBM argued, were bound together by their shared pre-acquisition history, creating a cohesive unit whose losses could be offset by Delavau’s NOLs post-liquidation.

The IRS, however, rejected both of HBM’s theories with equal force. On the lonely parent rule, the agency took a categorical view: the exception only applies to a parent’s own separate NOLs, not to those inherited from a predecessor corporation. The IRS pointed to Treasury Regulation § 1.1502-1(f)(2)(i), which explicitly limits the rule’s scope to NOLs "attributable to the parent’s separate return years." Delavau, the IRS argued, was not HBM’s predecessor in the statutory sense—it was a distinct entity whose NOLs arose in SRLYs. The agency further emphasized that Section 381, which governs the transfer of tax attributes in corporate liquidations, does not override the SRLY rules. Even if Delavau’s NOLs were transferred to HBM via the deemed liquidation under Section 332, the IRS maintained that they remained subject to SRLY limitations because they originated in a separate return year.

The IRS’s second line of defense was even more straightforward: Delavau was a predecessor of HBM, and the lonely parent rule does not apply to predecessors. The agency relied on Treasury Regulation § 1.1502-1(f)(2)(i), which defines a predecessor as a corporation whose tax attributes are carried over to another under Section 381. Since Delavau’s NOLs were transferred to HBM through a Section 332 liquidation—a transaction governed by Section 381—the IRS argued that Delavau fell squarely within the regulation’s definition of a predecessor. Under this reading, the lonely parent rule was inapplicable, and Delavau’s NOLs were forever barred from offsetting the HBM group’s consolidated income. The IRS also dismissed HBM’s SRLY subgroup argument, noting that the Founding Members had never been part of a consolidated group together before joining HBM. Without a shared SRLY history, the IRS contended, there could be no subgroup under Treasury Regulation § 1.1502-21(c)(2)(i).

The battle lines were drawn not just in dollars, but in legal principle. HBM’s arguments hinged on a narrow but potentially transformative interpretation of the lonely parent rule and SRLY subgroup mechanics, while the IRS staked out a rigid position that prioritized statutory text and regulatory hierarchy. The Tax Court would soon have to decide whether HBM’s reorganization had inadvertently created a tax structure where Delavau’s NOLs were trapped in legal limbo—or whether the company had found a legitimate path to unlock them.

The Court’s Verdict: Strict Interpretation of SRLY Rules Prevails

The Tax Court’s ruling in HBM Holdings, LLC v. Commissioner (T.C. Memo. 2026-5, July 15, 2026) delivered a decisive blow to HBM Holdings’ attempt to unlock $29.6 million in Delavau’s net operating loss (NOL) carryovers, siding entirely with the IRS in a sweeping rejection of the taxpayer’s creative—but ultimately unsustainable—interpretation of the consolidated return rules. The court’s 36-page opinion, authored by Judge Lauber, did more than just deny the deduction; it reaffirmed the Tax Court’s willingness to wield its interpretive authority over the IRS and other courts by enforcing the statutory text of the SRLY rules with uncompromising rigor. The decision underscores a broader judicial trend: when the IRS and taxpayers clash over the boundaries of consolidated return limitations, the court will not hesitate to prioritize the plain meaning of the regulations over policy-driven arguments.

The court’s analysis unfolded in three decisive stages, each dismantling a pillar of HBM’s argument with surgical precision. First, it rejected the notion that Delavau’s NOL carryovers could be treated as indistinguishable from HBM’s own tax attributes under § 381. Then, it dismantled HBM’s claim that the "lonely parent rule" exempted Delavau’s losses from SRLY restrictions. Finally, it demolished the taxpayer’s fallback position that the Founding Members constituted an SRLY subgroup, leaving no legal pathway for the NOLs to escape their statutory limbo.

Section 381’s Separate Tracking Requirement: No Integration of Predecessor NOLs

The court began by addressing the foundational premise of HBM’s case: whether Delavau’s NOL carryovers, inherited by HBM in a § 332 liquidation, were subject to the same tracking and limitation rules as HBM’s own tax attributes. The IRS argued—and the court agreed—that § 381 does not mandate the integration of predecessor and successor tax items for purposes beyond the proration rule in § 381(c)(1)(B). Instead, the regulations explicitly contemplate separate tracking of distributor and acquiring corporation carryovers in post-distribution years. As the court noted, Treasury Regulation § 1.381(c)(1)-1(e)(1) requires that the taxable income of an acquiring corporation be determined by "consider[ing] the acquiring corporation’s and distributor corporation’s NOL carryovers separately in years after the first tax year following the distribution." The court dismissed HBM’s reliance on Revenue Ruling 75-223 and Dover Corp. & Subsidiaries v. Commissioner, 122 T.C. 324 (2004), as inapposite, stating that those authorities addressed whether an acquiring corporation succeeds to a distributor’s business history—not whether the NOL carryovers themselves are tracked separately. "The broad reading that petitioner suggests," the court held, "would override clear statutory text in section 381(c)."

The court’s conclusion was unequivocal: "This Court does not agree that the Delavau NOL carryovers became indistinguishable from HBM NOL carryovers." The ruling thus established a critical precedent: in a § 381 transaction, predecessor NOLs are not merged into the successor’s general tax attribute pool but remain subject to their own distinct limitations.

Delavau as a Predecessor: The Lonely Parent Rule’s Inapplicability

HBM’s next line of defense hinged on the argument that Delavau was not a "predecessor" under Treasury Regulation § 1.1502-1(f)(4), which defines a predecessor as "a transferor or distributor of assets to a member (the successor) in a transaction to which section 381(a) applies." The taxpayer contended that HBM could not be Delavau’s successor because it was not a member of the HBM group at the time of the liquidation. The court, however, found this temporal argument unsupported by the regulatory text. As the opinion explained, Treasury Regulation § 1.1502-1(f)(4) does not condition successor status on group membership at the time of the transaction. Rather, it requires only that the successor be a member of the group for the relevant consolidated return year. The court emphasized that the regulation’s plain meaning controls, stating: "There is no textual basis in Treasury Regulation § 1.1502-1(f)(4) for petitioner’s position."

The court further rejected HBM’s assertion that the "lonely parent rule" (Treas. Reg. § 1.1502-1(f)(2)(i)) could exempt Delavau’s SRLYs from limitation. The lonely parent rule excludes from the definition of an SRLY the separate return years (SRYs) of a common parent corporation, but the court held that this exception does not extend to predecessors. The opinion highlighted the regulatory structure: while the lonely parent rule is the first of three exceptions to the SRLY definition, the second and third exceptions explicitly exclude SRYs of members and predecessors meeting certain conditions. If the lonely parent rule were interpreted to include predecessors, the court reasoned, these subsequent exceptions would be rendered superfluous. "The Delavau NOLs all arose in tax years of Delavau for which it filed a separate return," the court noted. "Because it is a predecessor of HBM, its SRYs constitute SRLYs under the general SRLY definition. None of the three SRLY exceptions applies with respect to the Delavau SRYs because Delavau is a predecessor that was never a member of the group."

No SRLY Subgroup: The Founding Members’ Disjointed Affiliation

HBM’s final gambit relied on the SRLY subgroup rules, arguing that the Founding Members—HBM and its disregarded entities—constituted a subgroup under Treasury Regulation § 1.1502-21(c)(2)(i), which permits NOL carryovers to offset income within a subgroup if the members joined the group together. The court, however, found that the Founding Members could not satisfy the regulation’s requirement that they were part of a "former group" before joining the HBM group. As the opinion explained, the Founding Members were either S corporations or disregarded entities immediately prior to the HBM group’s formation, and an S corporation cannot be a member of an affiliated group under § 1504(b)(6). "The Founding Members were not part of any prior affiliated group," the court held. "Until the current HBM group was formed, HBM was, and had always been, an S corporation."

The court also dismissed HBM’s policy-based argument that the subgroup rules should apply based on "economic reality" or "common control," citing Wolter Constr. Co. v. Commissioner, 68 T.C. 39, 44–45 (1977), for the principle that courts will not read exceptions into the regulations where none exist. "Any corporation seeking to deduct losses of another corporation from past years can do so only upon the authority of a specific provision," the court stated. The SRLY subgroup rules, it concluded, are designed to preserve aggregation for continuously affiliated corporations—not to create a loophole for entities that were never formally part of an affiliated group.

The SRLY NOL Limitation’s Final Barrier

With all of HBM’s arguments rejected, the court turned to the ultimate consequence: the application of the SRLY NOL limitation. Under Treasury Regulation § 1.1502-21(a)(1), a consolidated group may only take into account NOL carryovers arising in an SRLY to the extent of the group’s consolidated taxable income attributable to the member that generated the loss. Because Delavau’s NOL carryovers arose in an SRLY and the Founding Members did not constitute an SRLY subgroup, the court held that the HBM group could not utilize the losses to offset its income for the years at issue. "Because the Delavau NOL carryovers arose in an SRLY," the court concluded, "they cannot be included in the HBM group’s CNOL deductions for the years at issue. Therefore, the CNOL deductions claimed by the HBM group for the years at issue are not allowed."

The opinion’s closing lines left no room for ambiguity: "For these reasons, this Court finds that petitioner’s CNOL deductions based on Delavau’s NOL carryovers were properly disallowed." In doing so, the Tax Court not only resolved the dispute in favor of the IRS but also reasserted its authority to enforce the consolidated return rules with a strictness that leaves little room for taxpayer innovation. The message was clear: when it comes to SRLY limitations, the statute means what it says—and no amount of creative structuring can rewrite the rules.

What’s Next for Taxpayers? The Ripple Effects of HBM Holdings

The Tax Court’s decision in HBM Holdings LLC v. Commissioner (T.C. Memo. 2026-5, July 27, 2026) does not merely resolve a $29.6 million deficiency dispute—it reshapes the risk calculus for any taxpayer relying on net operating loss (NOL) carryovers in consolidated groups. The court’s strict interpretation of the Separate Return Limitation Year (SRLY) rules (Treas. Reg. § 1.1502-21) and the "lonely parent rule" (Treas. Reg. § 1.1502-1(f)(2)(i)) signals a new era of heightened scrutiny for NOL planning in reorganizations, particularly those involving deemed liquidations under § 332. Taxpayers who assume that NOL carryovers from a liquidated entity can offset consolidated income—even when the liquidated entity was never part of the consolidated group—face a stark warning: the Tax Court will not tolerate creative structuring that circumvents the statute’s plain language.

The court’s holding hinges on a foundational principle: NOL carryovers are not fungible assets. In HBM Holdings, the petitioner sought to apply Delavau’s pre-liquidation NOLs against the consolidated group’s income, arguing that the deemed liquidation under § 332 transferred the NOLs to HBM as the successor under § 381. The IRS countered that the NOLs were subject to SRLY limitations because Delavau was never part of the HBM consolidated group. The court sided entirely with the IRS, emphasizing that "the CNOL deductions claimed by the HBM group for the years at issue are not allowed" because the NOLs were SRLY losses and could not be used to offset income generated by unrelated members of the consolidated group. This ruling underscores that SRLY restrictions are not optional compliance formalities—they are jurisdictional barriers to NOL utilization.

For future taxpayers, the implications are severe. The court’s reasoning makes clear that § 381 does not override SRLY limitations. Even if a transaction qualifies for tax-free treatment under § 332 and attributes transfer under § 381, the successor’s ability to use those attributes is still constrained by the SRLY rules. As the court noted, "no amount of creative structuring can rewrite the rules"—a phrase that should haunt tax planners who rely on aggressive interpretations of predecessor-successor relationships. Practitioners must now assume that any NOL carryover from an entity that was never part of the consolidated group will be subject to SRLY limitations, regardless of how the transaction is structured.

The decision also delivers a sharp rebuke to taxpayers who misapply the "lonely parent rule". The court rejected HBM’s argument that Delavau’s NOLs qualified for favorable treatment under the lonely parent rule because HBM had never been part of a consolidated group before acquiring Delavau. The IRS countered that the lonely parent rule only applies when the parent corporation itself—not its acquired subsidiaries—has no prior consolidated group history. The court agreed, holding that the rule does not extend to NOLs generated by a subsidiary that was never part of the parent’s consolidated group. This narrow interpretation means taxpayers cannot rely on the lonely parent rule to shield NOLs from SRLY limitations unless the parent corporation itself was standalone in the year the NOLs were generated. The message is unambiguous: the lonely parent rule is not a loophole for loss trafficking.

The practical takeaways for tax practitioners are immediate and actionable. First, due diligence must now include a SRLY audit of any target entity’s NOLs, even in tax-free reorganizations. The court’s opinion makes it clear that the IRS and Tax Court will scrutinize the chronology of group membership with surgical precision. Taxpayers cannot assume that a deemed liquidation under § 332 will automatically preserve NOLs for consolidated use; instead, they must verify whether the liquidated entity’s NOLs are SRLY-limited before relying on them. Second, structuring reorganizations to avoid SRLY pitfalls is no longer optional. Practitioners should model the consolidated group’s income streams to ensure that SRLY losses can be matched to the correct subgroup, as the court’s strict subgroup analysis leaves little room for error. Third, foreign parents acquiring U.S. subsidiaries must reassess their NOL planning. The lonely parent rule’s narrow application means that foreign parents joining U.S. consolidated groups cannot assume their pre-group NOLs will escape SRLY limitations.

The Tax Court’s assertion of authority in HBM Holdings extends beyond the facts of the case. By enforcing the SRLY rules with uncompromising rigidity, the court has effectively elevated the consolidated return regulations to the status of statutory law, leaving taxpayers with little recourse for creative interpretation. The IRS’s victory here is not just a win in litigation—it is a declaration that the Tax Court will police the boundaries of NOL utilization with the same rigor as the statute itself. Taxpayers who ignore this message do so at their peril. The era of assuming that NOL carryovers are freely transferable in consolidated groups is over. The rules are clear, the court’s interpretation is strict, and the consequences of missteps are measured in millions.