Bulletin No. 1998–14

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Internal Revenue

bulletin

Bulletin No. 1998–14

April 6, 1998

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 98–18, page 22.

nized by a shareholder who receives, in exchange for the

shareholder’s stock, certain installment obligations that are

distributed upon the complete liquidation of a corporation.

Federal rates; adjusted federal rates; adjusted federal

long-term rate, and the long-term exempt rate. For

purposes of sections 1274, 1288, 382, and other sections

of the Code, tables set forth the rates for April 1998.

EXEMPT ORGANIZATIONS

T.D. 8760, page 4.

T.D. 8761, page 13.

REG–120882–97, page 25.

Final, temporary, and proposed regulations under section

368 of the Code provide guidance regarding satisfaction of

the continuity of interest and continuity of business enterprise requirements for corporate reorganizations. A public

hearing on the proposed regulations will be held on May 26,

1998.

T.D. 8762, page 15.

Final regulations under section 453 of the Code relate to

the use of the installment method to report the gain recog-

Finding Lists begin on page 32.

Index for January-March begins on page 34.

Department of the Treasury

Internal Revenue Service

Announcement 98–26, page 28.

A list is given of organizations now classified as private foundations.

ADMINISTRATIVE

REG–209373–81, page 26.

Proposed regulations under section 195 of the Code provide

rules and procedures for electing to amortize start-up expenditures. A public hearing will be held on June 2, 1998.

Mission of the Service

ucts and services; and perform in a manner warranting

the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect

the proper amount of tax revenue at the least cost; serve

the public by continually improving the quality of our prod-

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying and

administering the law in a reasonable, practical manner.

Issues should only be raised by examining officers when

they have merit, never arbitrarily or for trading purposes.

At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that

care be exercised not to raise an issue or to ask a court to

adopt a position inconsistent with an established Service

position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue

is determined by Congress.

With this in mind, it is the duty of the Service to carry out that

policy by correctly applying the laws enacted by Congress;

to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;

and to perform this work in a fair and impartial manner, with

neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It

should be conducted with as little delay as possible and

with great courtesy and considerateness. It should never

try to overreach, and should be reasonable within the

bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax devices and

fraud.

At the heart of administration is interpretation of the Code. It

is the responsibility of each person in the Service, charged

with the duty of interpreting the law, to try to find the true

meaning of the statutory provision and not to adopt a

strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only

when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold

on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking

and the disbarment and suspension list included in this part,

none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a semiannual basis

and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 42.—Low-Income

Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

Section 280G.—Golden

Parachute Payments

Federal short-term, mid-term, and long-term

rates are set forth for the month of April 1998. See

Rev. Rul. 98–18, page 22.

Section 368.—Definitions

Relating to Corporate

Reorganizations

26 CFR 1.368–1: Purpose and scope of exception of

reorganization exchanges.

T.D. 8760

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Continuity of Interest and

Continuity of Business

Enterprise

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations providing guidance regarding satisfaction of the continuity of

interest and continuity of business enterprise requirements for corporate reorganizations. The final regulations affect corporations and their shareholders.

DATES: These regulations are effective

January 28, 1998.

Applicability: These regulations apply

to transactions occurring after January 28,

1998, except that they do not apply to any

transaction occurring pursuant to a written agreement which is (subject to customary conditions) binding on January

28, 1998, and at all times thereafter.

FOR FURTHER INFORMATION CONTACT: Regarding §1.368–1(e) (continuity of interest), §§1.338–2 and 1.368–1(a)

April 6, 1998

and (b): Phoebe Bennett, (202) 622-7750

(not a toll-free number); regarding

§1.368–1(d) (continuity of business enterprise), §§1.368–1(a) and (b), and 1.368–

2(k): Marlene Peake Oppenheim, (202)

622-7750 (not a toll free number).

SUPPLEMENTARY INFORMATION:

Background

On December 23, 1996, the IRS published a notice of proposed rulemaking

(REG–252231–96 [1997–1 C.B. 800]) in

the Federal Register (61 F.R. 67512) relating to the continuity of interest (COI)

requirement (proposed COI regulations).

On January 3, 1997, the IRS published a

notice of proposed rulemaking (REG–

252233–96 [1997–1 C.B. 802]) in the

Federal Register (62 F.R. 36101) (proposed COBE regulations) relating to (1)

the continuity of business enterprise

(COBE) requirement; and (2) transfers of

acquired assets or stock following certain

otherwise qualifying reorganizations (remote continuity of interest). Many written comments were received in response

to these notices of proposed rulemaking.

A public hearing on both proposed regulations was held on May 7, 1997. After

consideration of all comments, the regulations proposed by REG–252231–96 and

REG–252233–96 are adopted as revised

by this Treasury decision, along with temporary regulations and proposed regulations cross-referencing the temporary regulations regarding COI published in T.D.

8761, page 13 of this Bulletin.

Explanation of Provisions

The Internal Revenue Code of 1986

provides general nonrecognition treatment

for reorganizations specifically described

in section 368. In addition to complying

with the statutory requirements and certain

other requirements, a transaction generally

must satisfy the continuity of interest requirement and the continuity of business

enterprise requirement.

A. Continuity of Interest

The purpose of the continuity of interest requirement is to prevent transactions

that resemble sales from qualifying for

nonrecognition of gain or loss available to

corporate reorganizations. The final regulations provide that the COI requirement

is satisfied if in substance a substantial

part of the value of the proprietary interest

in the target corporation (T) is preserved

in the reorganization. A proprietary interest in T is preserved if, in a potential reorganization, it is exchanged for a proprietary interest in the issuing corporation

(P), it is exchanged by the acquiring corporation for a direct interest in the T enterprise, or it otherwise continues as a

proprietary interest in T. The issuing corporation means the acquiring corporation

(as the term is used in section 368(a)), except that, in determining whether a reorganization qualifies as a triangular reorganization (as defined in §1.358–6(b)(2)),

the issuing corporation means the corporation in control of the acquiring corporation. However, a proprietary interest in T

is not preserved if, in connection with the

potential reorganization, it is acquired by

P for consideration other than P stock, or

P stock furnished in exchange for a proprietary interest in T in the potential reorganization is redeemed. All facts and circumstances must be considered in

determining whether, in substance, a proprietary interest in T is preserved.

Rationale for the COI regulations

The proposed and final regulations permit former T shareholders to sell P stock

received in a potential reorganization to

third parties without causing the reorganization to fail to satisfy the COI requirement. Some commentators have questioned whether the regulations are

consistent with existing authorities.

The COI requirement was applied first

to reorganization provisions that did not

specify that P exchange a proprietary interest in P for a proprietary interest in T.

Supreme Court cases imposed the COI requirement to further Congressional intent

that tax-free status be accorded only to

transactions where P exchanges a substantial proprietary interest in P for a proprietary interest in T held by the T shareholders rather than to transactions

resembling sales. See LeTulle v. Scofield,

308 U.S. 415 (1940); Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935);

Pinellas Ice & Cold Storage Co. v. Com-

1998–14 I.R.B.

missioner, 287 U.S. 462 (1933). See also

Cortland Specialty Co. v. Commissioner,

60 F.2d 937 (2d Cir. 1932), cert. denied

288 U.S. 599 (1933).

None of the Supreme Court cases establishing the COI requirement addressed the

issue of whether sales by former T shareholders of P stock received in exchange

for T stock in the potential reorganization

cause the COI requirement to fail to be

satisfied. Since then, however, some

courts have premised decisions on the assumption that sales of P stock received in

exchange for T stock in the potential reorganization may cause the COI requirement to fail to be satisfied. McDonald’s

Restaurants of Illinois, Inc. v. Commissioner, 688 F.2d 520 (7th Cir. 1982);

Penrod v. Commissioner, 88 T.C. 1415

(1987); Heintz v. Commissioner, 25 T.C.

132 (1955), nonacq., 1958–2 C.B. 9; Estate of Elizabeth Christian v. Commissioner, 57 T.C.M. (CCH) 1231 (1989).

The apparent focus of these cases is on

whether the T shareholders intended on

the date of the potential reorganization to

sell their P stock and the degree, if any, to

which P facilitates the sale. Based on an

intensive inquiry into nearly identical

facts, some of these cases held that as a

result of the subsequent sale the potential

reorganization did not satisfy the COI requirement; others held that satisfaction of

the COI requirement was not adversely

affected by the subsequent sale. The IRS

and Treasury Department have concluded

that the law as reflected in these cases

does not further the principles of reorganization treatment and is difficult for both

taxpayers and the IRS to apply consistently.

Therefore, consistent with Congressional intent and the Supreme Court

precedent which distinguishes between

sales and reorganizations, the final regulations focus the COI requirement generally

on exchanges between the T shareholders

and P. Under this approach, sales of P

stock by former T shareholders generally

are disregarded.

The final regulations will greatly enhance administrability in this area by both

taxpayers and the government. The regulations will prevent “whipsaw” of the

government, such as where the former T

shareholders treat the transaction as a taxfree reorganization, and P later disavows

reorganization treatment to step up its

1998–14 I.R.B.

basis in the T assets based on the position

that sales of P stock by the former T

shareholders did not satisfy the COI requirement. See, e.g., McDonald’s Restaurants, supra. In addition, this approach

will prevent unilateral sales of P stock by

former majority T shareholders from adversely affecting the section 354 nonrecognition treatment expected by former

minority T shareholders.

Dispositions of T stock

The proposed COI regulations do not

specifically address the effect upon COI

of dispositions of T stock prior to a potential reorganization, but ask for comments

on that issue. The IRS and Treasury Department believe that issues concerning

the COI requirement raised by dispositions of T stock before a potential reorganization correspond to those raised by

subsequent dispositions of P stock furnished in exchange for T stock in the potential reorganization. As requested by

commentators, the final regulations apply

the rationale of the proposed COI regulations to transactions occurring both prior

to and after a potential reorganization.

Cf. J.E. Seagram Corp. v. Commissioner,

104 T.C. 75 (1995) (sales of T stock prior

to a potential reorganization do not affect

COI if not part of the plan of reorganization). The final regulations provide that,

for COI purposes, a mere disposition of T

stock prior to a potential reorganization to

persons not related to P is disregarded and

a mere disposition of P stock received in a

potential reorganization to persons not related to P is disregarded. But see §1.368–

1T(e)(1)(ii)(A) and (B).

In soliciting comments on the effect

upon COI of dispositions of T stock prior

to a potential reorganization, the preamble

to the proposed COI regulations specifically requests comments on King Enterprises, Inc. v. United States, 418 F.2d 511

(Ct. Cl. 1969) (COI requirement satisfied

where, pursuant to a plan, P acquires the T

stock for 51 percent P stock and 49 percent debt and cash, and T merges upstream into P), and Yoc Heating Corp. v.

Commissioner, 61 T.C. 168 (1973) (COI

requirement not satisfied where, pursuant

to a plan, P acquires 85 percent of the T

stock for cash and notes, and T merges

into P’s newly formed subsidiary with minority shareholders receiving cash). Consistent with these cases, where the step

transaction doctrine applies to link T

stock purchases with later acquisitions of

T, the final regulations provide that a proprietary interest in T is not preserved if, in

connection with the potential reorganization, it is acquired by P for consideration

other than P stock. Whether a stock acquisition is made in connection with a potential reorganization will be determined

based on the facts and circumstances of

each case. See generally §1.368–1(a).

This regulation does not address the effect, if any, of section 338 on corporate

transactions (except for conforming

changes to §1.338–2(c)(3)). See generally §1.338–2(c)(3) (certain tax effects of

a qualified stock purchase without a section 338 election on the post-acquisition

elimination of T).

Related person rule

The proposed COI regulations provide

that “[i]n determining whether [COI is satisfied], all facts and circumstances must

be considered, including any plan or

arrangement for the acquiring corporation

or its successor corporation (or a person

related to the acquiring corporation or its

successor corporation within the meaning

of section 707(b)(1) or 267(b) (without regard to section 267(e))) to redeem or acquire the consideration provided in the reorganization.” The final regulations

provide a more specific rule that a proprietary interest in T is not preserved if, in

connection with a potential reorganization, a person related (as defined below) to

P acquires, with consideration other than a

proprietary interest in P, T stock or P stock

furnished in exchange for a proprietary interest in T in the potential reorganization.

The IRS and Treasury Department believe, however, that certain related party

acquisitions preserve a proprietary interest

in T and therefore, the rule includes an exception to the related party rule. Under

this exception, a proprietary interest in T is

preserved to the extent those persons who

were the direct or indirect owners of T

prior to the potential reorganization maintain a direct or indirect proprietary interest in P. See, e.g., Rev. Rul. 84–30

(1984–1 C.B. 114).

Commentators stated that the proposed

COI regulations’ rule, which employs sections 707(b)(1) and 267(b) to define persons related to P, is too broad. In response, the final regulations adopt a

April 6, 1998

narrower related person definition which

has two components in order to address

two separate concerns.

First, the IRS and Treasury Department

were concerned that acquisitions of T or P

stock by a member of P’s affiliated group

were no different in substance from an acquisition or redemption by P, because of

the existence of various provisions in the

Code that permit members to transfer

funds to other members without significant tax consequences. Accordingly,

§1.368–1(e)(3)(i)(A) includes as related

persons corporations that are members of

the same affiliated group under section

1504, without regard to the exceptions in

section 1504(b).

Second, because the final regulations

take into account whether, in substance, P

has redeemed the stock it exchanged for T

stock in the potential reorganization, the

final regulations treat two corporations as

related persons if a purchase of the stock

of one corporation by another corporation

would be treated as a distribution in redemption of the stock of the first corporation under section 304(a)(2) (determined

without regard to §1.1502–80(b)).

Because the final regulations focus generally on the consideration P exchanges,

related persons do not include individual

or other noncorporate shareholders. Thus,

the IRS will no longer apply the holdings

of South Bay Corporation v. Commissioner, 345 F.2d 698 (2d Cir. 1965), and

Superior Coach of Florida, Inc. v. Commissioner, 80 T.C. 895 (1983), to transactions governed by these regulations.

T stock not acquired in connection with a

potential reorganization

Commentators requested clarification

of whether P must actually furnish stock

to T shareholders that own T stock which

was not acquired in connection with a potential reorganization. The final regulations provide that a proprietary interest in

T is preserved if it is exchanged by the acquiring corporation (which may or may

not also be P) for a direct interest in the T

enterprise, or otherwise continues as a

proprietary interest in T.

Redemptions of T stock or extraordinary

distributions with respect to T stock

In addition to the final regulations, the

IRS and Treasury Department are con-

April 6, 1998

temporaneously issuing temporary regulations and proposed regulations crossreferencing the temporary regulations

published in T.D. 8761 with the same effective date as these final regulations.

The temporary and proposed regulations

provide that a proprietary interest in T is

not preserved if, in connection with a potential reorganization, it is redeemed or

acquired by a person related to T, or to

the extent that, prior to and in connection

with a potential reorganization, an extraordinary distribution is made with respect to it.

Transactions following a qualified stock

purchase

As stated above, these final regulations

focus the COI requirement generally on

exchanges between the T shareholders

and P. Accordingly, the language of

§1.338–2(c)(3) is conformed to these

final COI regulations to treat the stock of

T acquired by the purchasing corporation

in the qualified stock purchase as though

it was not acquired in connection with the

transfer of the T assets.

Effect on other authorities

The IRS and Treasury Department continue to study the role of the COI requirement in section 368(a)(1)(D) reorganizations and section 355 transactions.

Therefore, these final COI regulations do

not apply to section 368(a)(1)(D) reorganizations and section 355 transactions.

See §1.355–2(c).

These COI regulations apply solely for

purposes of determining whether the COI

requirement is satisfied. No inference

should be drawn from any provision of

this regulation as to whether other reorganization requirements are satisfied, for

example, whether P has issued solely voting stock for purposes of section 368(a)(1)(B) or (C).

Effect on other documents

Rev. Proc. 77–37 (1977–2 C.B. 568)

and Rev. Proc. 86–42 (1986–2 C.B. 722)

will be modified to the extent inconsistent

with these regulations.

Rev. Rul. 66–23 (1966–1 C.B. 67) is

hereby obsoleted because it indicates that

a plan or arrangement in connection with

a potential reorganization for disposition

of stock to unrelated persons does not satisfy the COI requirement.

B. Continuity of Business Enterprise

The COBE requirement is fundamental

to the notion that tax-free reorganizations

merely readjust continuing interests in

property. In §1.368–1(d), as effective

prior to these final regulations, COBE

generally required the acquiring corporation to either continue a significant historic T business or use a significant portion of T’s historic business assets in a

business. However, a valid reorganization may qualify as tax-free even if the acquiring corporation does not directly

carry on the historic T business or use the

historic T assets in a business. See section 368(a)(2)(C). See also Rev. Rul. 68–

261 (1968–1 C.B. 147); Rev. Rul. 81–247

(1981–1 C.B. 87).

Consistent with the view that the acquiring corporation need not directly conduct the T business or use the T assets, the

final regulations provide rules under

which, in an otherwise qualifying corporate reorganization, the assets and the

businesses of the members of a qualified

group of corporations are treated as assets

and businesses of the issuing corporation.

Accordingly, in the final regulations,

COBE requires that the issuing corporation either continue T’s historic business

or use a significant portion of T’s historic

business assets in a business.

A qualified group is one or more chains

of corporations connected through stock

ownership with the issuing corporation,

but only if the issuing corporation owns

directly stock meeting the requirements of

section 368(c) in at least one of the corporations, and stock meeting the requirements of section 368(c) in each of the corporations is owned directly by one of the

other corporations.

The judicial continuity of interest doctrine historically included a concept commonly known as remote continuity of interest. Commonly viewed as arising out

of Groman v. Commissioner, 302 U.S. 82

(1937), and Helvering v. Bashford, 302

U.S. 454 (1938), remote continuity of interest focuses on the link between the T

shareholders and the former T business

assets following the reorganization. In

§1.368–1(d), as effective prior to these

final regulations, COBE focuses on the

continuation of T’s business, or the use of

1998–14 I.R.B.

T’s business assets, by the acquiring corporation. Section 1.368–1(d), as revised

herein, expands this concept by treating

the issuing corporation as conducting a T

business or owning T business assets if

these activities are conducted by a member of the qualified group or, in certain

cases, by a partnership that has a member

of the qualified group as a partner.

The proposed COBE regulations separately address COBE (§1.368–1(d)) and

remote continuity of interest (§1.368–

1(f)). The IRS and Treasury Department

believe the COBE requirements adequately address the issues raised in Groman and Bashford and their progeny.

Thus, these final regulations do not separately articulate rules addressing remote

continuity of interest.

Definition of the qualified group

The proposed COBE regulations define

the qualified group using a control test

based on section 368(c). The IRS and

Treasury Department received comments

suggesting the replacement of the section

368(c) definition of control by the affiliated group definition of control stated in

section 1504, without regard to section

1504(b). However, because section 368

generally determines control by reference

to section 368(c), the final regulations retain the approach of the proposed COBE

regulations.

Rules for aggregation of interests in

historic T assets and businesses held in

partnership solution

In determining whether COBE is satisfied, the proposed COBE regulations aggregate the interests of the members of a

qualified group. In addition, the proposed

COBE regulations attribute a business of

a partnership to a corporate transferor

partner if the partner has a sufficient

nexus with that partnership business.

However, the proposed COBE regulations

only consider the transferor partner’s interest in the partnership business, and do

not aggregate this interest with interests in

the partnership held by other members of

the qualified group.

In response to comments requesting a

partnership aggregation rule, the final

regulations, through a system of attribution, aggregate the interests in a partnership business held by all the members of a

1998–14 I.R.B.

qualified group. The final regulations

provide rules under which a corporate

partner may be treated as holding assets

of a business of a partnership. Additionally, P is treated as holding all the assets,

and conducting all the businesses of its

qualified group. Furthermore, in certain

circumstances, P will be treated as conducting a business of a partnership. Once

the relevant T businesses and T assets are

attributed to P, COBE is tested under the

general rule of the final COBE regulations. See §1.368–1(d)(1).

The proposed COBE regulations do not

discuss tiered partnerships. In response to

comments, the final regulations provide

guidance on this issue. See §1.368–

1(d)(5), Example 12.

C. Transfers of Assets or Stock to

Controlled Corporations as Part of a

Plan of Reorganization

The proposed COBE regulations are

limited in their application to COBE and

remote continuity of interest. The rules of

the proposed COBE regulations provide

that for certain reorganizations, transfers

of acquired assets or stock among members of the qualified group, and in certain

cases, transfers of acquired assets to partnerships, do not disqualify a transaction

from satisfying the COBE and remote

continuity of interest requirements. The

preamble to the proposed COBE regulations states that these rules do not address

any other issues concerning the qualification of a transaction as a reorganization.

Comments suggest that the proposed

COBE regulations are ambiguous as they

could be interpreted to mean that a transfer of stock or assets to a qualified group

member after an otherwise tax-free reorganization would be given independent

significance and the step transaction doctrine would not apply. Under such an interpretation, the potential reorganization

would not be recast as a taxable acquisition or another type of reorganization. To

eliminate this ambiguity, §1.368–1(a) of

the final regulations provides that, in determining whether a transaction qualifies

as a reorganization under section 368(a),

the transaction must be evaluated under

relevant provisions of law, including the

step transaction doctrine. Section 1.368–

1(d) of the final regulations is limited to a

discussion of the COBE requirement, and

does not address satisfaction of the ex-

plicit statutory requirements of a reorganization, which is the subject of §1.368–

2. However, §1.368–2(k) of the final

regulations does provide guidance in this

regard, extending the application of section 368(a)(2)(C) to certain successive

transfers.

Section 1.368–2(k) of the final regulations states that a transaction otherwise

qualifying under section 368(a)(1)(A), (B),

(C), or (G) (where the requirements of sections 354(b)(1)(A) and (B) are met) shall

not be disqualified by reason of the fact

that part or all of the acquired assets or

stock acquired in the transaction are transferred or successively transferred to one or

more corporations controlled in each transfer by the transferor corporation. Control

is defined under section 368(c). The final

regulations also provide a rule for transfers

of assets following a reorganization qualifying under section 368(a)(1)(A) by reason

of section 368(a)(2)(E). No inference is to

be drawn as to whether transactions not described in §1.368–2(k) otherwise qualify

as reorganizations.

The final regulations also provide that,

if a transaction otherwise qualifies as a reorganization, a corporation remains a

party to the reorganization even though

stock or assets acquired in the reorganization are transferred in a transaction described in §1.368–2(k). See §1.368–2(f).

Furthermore, if a transaction otherwise

qualifies as a reorganization, a corporation shall not cease to be a party to the reorganization solely because acquired assets are transferred to a partnership in

which the transferor is a partner if the

COBE requirement is satisfied.

Section 368(a)(1)(D), 368(a)(1)(F), and

355 transactions

The proposed COBE regulations, applying only to the COBE and remote continuity of interest requirements, are limited to transactions otherwise qualifying

for reorganization treatment under section

368(a)(1)(A), (B), (C), or (G) (where the

requirements of sections 354(b)(1)(A)

and (B) are met). The IRS and Treasury

Department received comments stating

that the final regulations should apply to

reorganizations qualifying under section

368(a)(1)(D) or (F) or to transactions

qualifying under section 355.

The final regulations do not limit the

application of §1.368–1(d) to the transac-

April 6, 1998

tions enumerated in section 368(a)(2)(C).

The COBE provisions in the final regulations apply to all reorganizations for

which COBE is relevant.

Section 1.368–2(k)(1) of the final regulations, however, is limited in its application to the transactions described in section 368(a)(2)(C), and does not apply in

determining whether a reorganization

qualifies under section 368(a)(1)(D), section 368(a)(1)(F), or section 355. The

IRS and Treasury Department believe that

further study is needed prior to extending

§1.368–2(k)(1) to one or more of these

provisions.

Effective Date

The amendments to these regulations

apply to transactions occurring after January 28, 1998, except that they do not

apply to any transaction occurring pursuant to a written agreement which is

(subject to customary conditions) binding

on January 28, 1998, and at all times

thereafter. Commentators requested that

the effective date be changed to allow

these regulations to apply to transactions

occurring on or before January 28, 1998.

The IRS and Treasury Department believe

that adopting an earlier effective date increases the likelihood that T, P, and each

of the former T shareholders would report

the transaction inconsistently (in some

cases using hindsight), and would reduce

administrability of the regulation. No inference should be drawn from any provision of this regulation as to application of

the COI or COBE requirements to transactions occurring on or before January 28,

1998.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not

apply to these regulations, and because

the regulation does not impose a collection of information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, the notices of proposed rulemaking

preceding these regulations were submit-

April 6, 1998

ted to the Chief Counsel for Advocacy of

the Small Business Administration for

comment on their impact on small business.

Drafting Information

The principal authors of these regulations are Phoebe Bennett, regarding

§1.368–1(e) (continuity of interest), and

Marlene Peake Oppenheim, regarding

§1.368–1(d) (continuity of business enterprise) and §1.368–2(k), both of the Office

of the Assistant Chief Counsel (Corporate), IRS. However, other personnel

from the IRS and Treasury Department

participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is amended

as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.338-2 is amended:

1. By revising paragraph (c)(3)(ii).

2. In paragraph (c)(3)(iv) Example by

revising the first sentence of paragraph

(B).

The revisions read as follows:

§1.338–2 Miscellaneous issues under

section 338.

(3) * * *

(ii) Continuity of interest. By virtue of

section 338, in determining whether the

continuity of interest requirement of

§1.368–1(b) and (e) is satisfied on the

transfer of assets from target to the transferee, the purchasing corporation’s target

stock acquired in the qualified stock purchase shall be treated as though it was not

acquired in connection with the transfer

of target assets.

(iv) Example. * * *

(B) Status of transfer as a reorganization. By virtue of section 338, for the

purpose of determining whether the continuity of interest requirement of §1.368–

1(b) is satisfied, P’s T stock acquired in

the qualified stock purchase shall be

treated as though it was not acquired in

connection with the transfer of T assets to

X. * * *

Par. 3. Section 1.368–1 is amended by:

1. Adding three sentences immediately

following the first sentence of paragraph

(a).

2. Removing the third sentence and

adding four sentences in its place to paragraph (b).

3. Removing paragraph (d)(1).

4. Redesignating paragraphs (d)(2),

(d)(3), and (d)(4) as paragraphs (d)(1),

(d)(2), and (d)(3), respectively.

5. Removing the first sentence of

newly designated paragraph (d)(1) and

adding two sentences in its place.

6. Adding new paragraph (d)(4).

7. Paragraph (d)(5) is amended by:

a. Adding two sentences to the end of

paragraph (d)(5) introductory text.

b. Removing the parentheses around

the numbers in the paragraph headings for

Example (1) through Example (5).

c. Adding Example 6 through Example

12.

8. Adding paragraph (e).

The additions and revisions read as follows:

§1.368–1 Purpose and scope of

exception of reorganization exchanges.

(a) * * * In determining whether a

transaction qualifies as a reorganization

under section 368(a), the transaction must

be evaluated under relevant provisions of

law, including the step transaction doctrine. But see §§1.368–2(f) and (k) and

1.338–2(c)(3). The preceding two sentences apply to transactions occurring

after January 28, 1998, except that they

do not apply to any transaction occurring

pursuant to a written agreement which is

binding on January 28, 1998, and at all

times thereafter. * * *

(b) * * * Requisite to a reorganization

under the Internal Revenue Code are a

continuity of the business enterprise

through the issuing corporation under the

modified corporate form as described in

paragraph (d) of this section, and (except

1998–14 I.R.B.

as provided in section 368(a)(1)(D)) a

continuity of interest as described in paragraph (e) of this section. (For rules regarding the continuity of interest requirement under section 355, see §1.355–2(c).)

For purposes of this section, the term issuing corporation means the acquiring

corporation (as that term is used in section

368(a)), except that, in determining

whether a reorganization qualifies as a triangular reorganization (as defined in

§1.358–6(b)(2)), the issuing corporation

means the corporation in control of the

acquiring corporation. The preceding

three sentences apply to transactions occurring after January 28, 1998, except that

they do not apply to any transaction occurring pursuant to a written agreement

which is binding on January 28, 1998, and

at all times thereafter. * * *

(d) Continuity of business enterprise—

(1) General rule. Continuity of business

enterprise (COBE) requires that the issuing corporation (P), as defined in paragraph (b) of this section, either continue

the target corporation’s (T’s) historic

business or use a significant portion of T’s

historic business assets in a business. The

preceding sentence applies to transactions

occurring after January 28, 1998, except

that it does not apply to any transaction

occurring pursuant to a written agreement

which is binding on January 28, 1998, and

at all times thereafter. * * *

(4) Acquired assets or stock held by

members of the qualified group or partnerships. The following rules apply in

determining whether the COBE requirement of paragraph (d)(1) of this section is

satisfied:

(i) Businesses and assets of members

of a qualified group. The issuing corporation is treated as holding all of the businesses and assets of all of the members of

the qualified group, as defined in paragraph (d)(4)(ii) of this section.

(ii) Qualified group. A qualified group

is one or more chains of corporations connected through stock ownership with the

issuing corporation, but only if the issuing

corporation owns directly stock meeting

the requirements of section 368(c) in at

least one other corporation, and stock

meeting the requirements of section

1998–14 I.R.B.

368(c) in each of the corporations (except

the issuing corporation) is owned directly

by one of the other corporations.

(iii) Partnerships—(A) Partnership

assets. Each partner of a partnership will

be treated as owning the T business assets

used in a business of the partnership in accordance with that partner’s interest in the

partnership.

(B) Partnership businesses. The issuing corporation will be treated as conducting a business of a partnership if —

(1) Members of the qualified group, in

the aggregate, own an interest in the partnership representing a significant interest

in that partnership business; or

(2) One or more members of the qualified group have active and substantial

management functions as a partner with

respect to that partnership business.

in a partnership. If a significant historic

T business is conducted in a partnership,

the fact that P is treated as conducting

such T business under paragraph (d)(4)(iii)(B) of this section tends to establish

the requisite continuity, but is not alone

sufficient.

(iv) Effective date. This paragraph

(d)(4) applies to transactions occurring

after January 28, 1998, except that it does

not apply to any transaction occurring

pursuant to a written agreement which is

binding on January 28, 1998, and at all

times thereafter.

(5) * * * All corporations have only

one class of stock outstanding. The preceding sentence and paragraph (d)(5) Example 6 through Example 12 apply to

transactions occurring after January 28,

1998, except that they do not apply to any

transaction occurring pursuant to a written agreement which is binding on January 28, 1998, and at all times thereafter.

Example 6. Use of a significant portion of T’s

historic business assets by the qualified group. (i)

Facts. T operates an auto parts distributorship. P

owns 80 percent of the stock of a holding company

(HC). HC owns 80 percent of the stock of ten subsidiaries, S–1 through S–10. S–1 through S–10 each

separately operate a full service gas station. Pursuant to a plan of reorganization, T merges into P

and the T shareholders receive solely P stock. As

part of the plan of reorganization, P transfers T’s assets to HC, which in turn transfers some of the T assets to each of the ten subsidiaries. No one subsidiary receives a significant portion of T’s historic

business assets. Each of the subsidiaries will use the

T assets in the operation of its full service gas station. No P subsidiary will be an auto parts distributor.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(i) of this section, P is treated as

conducting the ten gas station businesses of S–1

through S–10 and as holding the historic T assets

used in those businesses. P is treated as holding all

the assets and conducting the businesses of all of the

members of the qualified group, which includes S–1

through S–10 (paragraphs (d)(4)(i) and (ii) of this

section). No member of the qualified group continues T’s historic distributorship business. However,

subsidiaries S–1 through S–10 continue to use the

historic T assets in a business. Even though no one

corporation of the qualified group is using a significant portion of T’s historic business assets in a business, the COBE requirement of paragraph (d)(1) of

this section is satisfied because, in the aggregate, the

qualified group is using a significant portion of T’s

historic business assets in a business.

Example 7. Continuation of the historic T business in a partnership satisfies continuity of business

enterprise. (i) Facts. T manufactures ski boots. P

owns all of the stock of S–1. S–1 owns all of the

stock of S–2, and S–2 owns all of the stock of S–3.

T merges into P and the T shareholders receive consideration consisting of P stock and cash. The T ski

boot business is to be continued and expanded. In

anticipation of this expansion, P transfers all of the T

assets to S–1, S–1 transfers all of the T assets to S–2,

and S–2 transfers all of the T assets to S–3. S–3 and

X (an unrelated party) form a new partnership

(PRS). As part of the plan of reorganization, S–3

transfers all the T assets to PRS, and S–3, in its capacity as a partner, performs active and substantial

management functions for the PRS ski boot business, including making significant business decisions and regularly participating in the overall supervision, direction, and control of the employees of

the ski boot business. S–3 receives a 20 percent interest in PRS. X transfers cash in exchange for an

80 percent interest in PRS.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(iii)(B)(2) of this section, P is

treated as conducting T’s historic business because

S–3 performs active and substantial management

functions for the ski boot business in S–3’s capacity

as a partner. P is treated as holding all the assets and

conducting the businesses of all of the members of

the qualified group, which includes S–3 (paragraphs

(d)(4)(i) and (ii) of this section). The COBE requirement of paragraph (d)(1) of this section is satisfied.

Example 8. Continuation of the historic T business in a partnership does not satisfy continuity of

business enterprise. (i) Facts. The facts are the

same as Example 7 except that S–3 transfers the historic T business to PRS in exchange for a 1 percent

interest in PRS.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(iii)(B)(2) of this section, P is

treated as conducting T’s historic business because

S–3 performs active and substantial management

functions for the ski boot business in S–3’s capacity

as a partner. The fact that a significant historic T

business is conducted in PRS, and P is treated as

conducting such T business under (d)(4)(iii)(B)

tends to establish the requisite continuity, but is not

alone sufficient (paragraph (d)(4)(iii)(C) of this sec-

April 6, 1998

tion). The COBE requirement of paragraph (d)(1) of

this section is not satisfied.

Example 9. Continuation of the T historic business in a partnership satisfies continuity of business

enterprise. (i) Facts. The facts are the same as Example 7 except that S–3 transfers the historic T business to PRS in exchange for a 331⁄3 percent interest

in PRS, and no member of P’s qualified group performs active and substantial management functions

for the ski boot business operated in PRS.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(iii)(B)(1) of this section, P is

treated as conducting T’s historic business because

S–3 owns an interest in the partnership representing

a significant interest in that partnership business. P

is treated as holding all the assets and conducting the

businesses of all of the members of the qualified

group, which includes S–3 (paragraphs (d)(4)(i) and

(ii) of this section). The COBE requirement of paragraph (d)(1) of this section is satisfied.

Example 10. Use of T’s historic business assets

in a partnership business. (i) Facts. T is a fabric

distributor. P owns all of the stock of S–1. T merges

into P and the T shareholders receive solely P stock.

S–1 and X (an unrelated party) own interests in a

partnership (PRS). As part of the plan of reorganization, P transfers all of the T assets to S–1, and S–1

transfers all the T assets to PRS, increasing S–1’s

percentage interest in PRS from 5 to 331⁄3 percent.

After the transfer, X owns the remaining 662⁄3 percent interest in PRS. Almost all of the T assets consist of T’s large inventory of fabric, which PRS uses

to manufacture sportswear. All of the T assets are

used in the sportswear business. No member of P’s

qualified group performs active and substantial

management functions for the sportswear business

operated in PRS.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(iii)(A) of this section, S–1 is

treated as owning 331⁄3 percent of the T assets used in

the PRS sportswear manufacturing business. Under

paragraph (d)(4)(iii)(B)(1) of this section, P is

treated as conducting the sportswear manufacturing

business because S–1 owns an interest in the partnership representing a significant interest in that

partnership business. P is treated as holding all the

assets and conducting the businesses of all of the

members of the qualified group, which includes S–1

(paragraphs (d)(4)(i) and (ii) of this section). The

COBE requirement of paragraph (d)(1) of this section is satisfied.

Example 11. Aggregation of partnership interests among members of the qualified group: use of

T’s historic business assets in a partnership business. (i) Facts. The facts are the same as Example

10, except that S–1 transfers all the T assets to PRS,

and P and X each transfer cash to PRS in exchange

for partnership interests. After the transfers, P owns

11 percent, S–1 owns 221⁄3 percent, and X owns 662⁄3

percent of PRS.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(iii)(B)(1) of this section, P is

treated as conducting the sportswear manufacturing

business because members of the qualified group, in

the aggregate, own an interest in the partnership representing a significant interest in that business. P is

treated as owning 11 percent of the assets directly,

and S–1 is treated as owning 221⁄3 percent of the assets, used in the PRS sportswear business (paragraph

April 6, 1998

(d)(4)(iii)(A) of this section). P is treated as holding

all the assets of all of the members of the qualified

group, which includes S–1, and thus in the aggregate, P is treated as owning 331⁄3 of the T assets

(paragraph (d)(4)(i) and (ii) of this section). The

COBE requirement of paragraph (d)(1) of this section is satisfied because P is treated as using a significant portion of T’s historic business assets in its

sportswear manufacturing business.

Example 12. Tiered partnerships: use of T’s historic business assets in a partnership business. (i)

Facts. T owns and manages a commercial office

building in state Z. Pursuant to a plan of reorganization, T merges into P, solely in exchange for P stock,

which is distributed to the T shareholders. P transfers all of the T assets to a partnership, PRS–1,

which owns and operates television stations nationwide. After the transfer, P owns a 50 percent interest

in PRS–1. P does not have active and substantial

management functions as a partner with respect to

the PRS–1 business. X, not a member of P’s qualified group, owns the remaining 50 percent interest in

PRS–1. PRS–1, in an effort to expand its state Z

television operation, enters into a joint venture with

U, an unrelated party. As part of the plan of reorganization, PRS–1 transfers all the T assets and its

state Z television station to PRS–2, in exchange for a

75 percent partnership interest. U contributes cash

to PRS–2 in exchange for a 25 percent partnership

interest and oversees the management of the state Z

television operation. PRS–1 does not actively and

substantially manage PRS–2’s business. PRS–2’s

state Z operations are moved into the acquired T office building. All of the assets that P acquired from

T are used in PRS–2’s business.

(ii) Continuity of business enterprise. Under

paragraph (d)(4)(iii)(A) of this section, PRS–1 is

treated as owning 75 percent of the T assets used in

PRS–2’s business. P, in turn, is treated as owning 50

percent of PRS–1’s interest the T assets. Thus, P is

treated as owning 371⁄2 percent (50 percent ⫻ 75 percent) of the T assets used in the PRS-2 business.

Under paragraph (d)(4)(iii)(B)(1) of this section, P is

treated as conducting PRS–2’s business, the operation of the state Z television station, and under paragraph (d)(4)(iii)(A) of this section, P is treated as

using 371⁄2 percent of the historic T business assets in

that business. The COBE requirement of paragraph

(d)(1) of this section is satisfied because P is treated

as using a significant portion of T’s historic business

assets in its television business.

(e) Continuity of interest—(1) General

rule. (i) The purpose of the continuity of

interest requirement is to prevent transactions that resemble sales from qualifying

for nonrecognition of gain or loss available to corporate reorganizations. Continuity of interest requires that in substance

a substantial part of the value of the proprietary interests in the target corporation

be preserved in the reorganization. A proprietary interest in the target corporation is

preserved if, in a potential reorganization,

it is exchanged for a proprietary interest in

the issuing corporation (as defined in para-

graph (b) of this section), it is exchanged

by the acquiring corporation for a direct

interest in the target corporation enterprise, or it otherwise continues as a proprietary interest in the target corporation.

However, a proprietary interest in the target corporation is not preserved if, in connection with the potential reorganization,

it is acquired by the issuing corporation

for consideration other than stock of the

issuing corporation, or stock of the issuing

corporation furnished in exchange for a

proprietary interest in the target corporation in the potential reorganization is redeemed. All facts and circumstances must

be considered in determining whether, in

substance, a proprietary interest in the target corporation is preserved. For purposes

of the continuity of interest requirement, a

mere disposition of stock of the target corporation prior to a potential reorganization

to persons not related (as defined in paragraph (e)(3) of this section determined

without regard to paragraph (e)(3)(i)(A) of

this section) to the target corporation or to

persons not related (as defined in paragraph (e)(3) of this section) to the issuing

corporation is disregarded and a mere disposition of stock of the issuing corporation

received in a potential reorganization to

persons not related (as defined in paragraph (e)(3) of this section) to the issuing

corporation is disregarded.

(ii) [Reserved] For further guidance

see §1.368–1T(e)(1)(ii)(A) and (B).

(2) Related person acquisitions. (i) A

proprietary interest in the target corporation is not preserved if, in connection with

a potential reorganization, a person related (as defined in paragraph (e)(3) of

this section) to the issuing corporation acquires, with consideration other than a

proprietary interest in the issuing corporation, stock of the target corporation or

stock of the issuing corporation furnished

in exchange for a proprietary interest in

the target corporation in the potential reorganization, except to the extent those

persons who were the direct or indirect

owners of the target corporation prior to

the potential reorganization maintain a direct or indirect proprietary interest in the

issuing corporation.

(ii) [Reserved] For further guidance

see §1.368–1T(e)(2)(ii).

(3) Definition of related person—(i)

In general. For purposes of this para-

1998–14 I.R.B.

graph (e), two corporations are related

persons if either—

(A) The corporations are members of

the same affiliated group as defined in

section 1504 (determined without regard

to section 1504(b)); or

(B) A purchase of the stock of one corporation by another corporation would be

treated as a distribution in redemption of

the stock of the first corporation under

section 304(a)(2) (determined without regard to §1.1502-80(b)).

(ii) Special rules. The following rules

apply solely for purposes of this paragraph (e)(3):

(A) A corporation will be treated as related to another corporation if such relationship exists immediately before or immediately after the acquisition of the

stock involved.

(B) A corporation, other than the target

corporation or a person related (as defined

in paragraph (e)(3) of this section determined without regard to paragraph

(e)(3)(i)(A) of this section) to the target

corporation, will be treated as related to

the issuing corporation if the relationship

is created in connection with the potential

reorganization.

(4) Acquisitions by partnerships. For

purposes of this paragraph (e), each partner of a partnership will be treated as

owning or acquiring any stock owned or

acquired, as the case may be, by the partnership in accordance with that partner’s

interest in the partnership. If a partner is

treated as acquiring any stock by reason

of the application of this paragraph (e)(4),

the partner is also treated as having furnished its share of any consideration furnished by the partnership to acquire the

stock in accordance with that partner’s interest in the partnership.

(5) Successors and predecessors. For

purposes of this paragraph (e), any reference to the issuing corporation or the target corporation includes a reference to

any successor or predecessor of such corporation, except that the target corporation is not treated as a predecessor of the

issuing corporation and the issuing corporation is not treated as a successor of the

target corporation.

(6) Examples. For purposes of the examples in this paragraph (e)(6), P is the issuing corporation, T is the target corporation, S is a wholly owned subsidiary of P,

all corporations have only one class of

1998–14 I.R.B.

stock outstanding, A and B are individuals, PRS is a partnership, all reorganization requirements other than the continuity of interest requirement are satisfied,

and the transaction is not otherwise subject to recharacterization. The following

examples illustrate the application of this

paragraph (e):

Example 1. Sale of stock to third party. (i) Sale

of issuing corporation stock after merger. A owns

all of the stock of T. T merges into P. In the merger,

A receives P stock having a fair market value of

$50x and cash of $50x. Immediately after the

merger, and pursuant to a preexisting binding contract, A sells all of the P stock received by A in the

merger to B. Assume that there are no facts and circumstances indicating that the cash used by B to

purchase A’s P stock was in substance exchanged by

P for T stock. Under paragraphs (e)(1) and (2) of

this section, the sale to B is disregarded because B is

not a person related to P within the meaning of paragraph (e)(3) of this section. Thus, the transaction

satisfies the continuity of interest requirement because 50 percent of A’s T stock was exchanged for P

stock, preserving a substantial part of the value of

the proprietary interest in T.

(ii) Sale of target corporation stock before

merger. The facts are the same as paragraph (i) of

this Example 1, except that B buys A’s T stock prior

to the merger of T into P and then exchanges the T

stock for P stock having a fair market value of $50x

and cash of $50x. The sale by A is disregarded. The

continuity of interest requirement is satisfied because B’s T stock was exchanged for P stock, preserving a substantial part of the value of the proprietary interest in T.

Example 2. Relationship created in connection

with potential reorganization. A owns all of the

stock of T. X, a corporation which owns 60 percent

of the P stock and none of the T stock, buys A’s T

stock for cash prior to the merger of T into P. X exchanges the T stock solely for P stock in the merger

which, when combined with X’s prior ownership of

P stock, constitutes 80 percent of the stock of P. X is

a person related to P under paragraphs (e)(3)(i)(A)

and (ii)(B) of this section, because X becomes affiliated with P in the merger. The continuity of interest

requirement is not satisfied, because X acquired a

proprietary interest in T for consideration other than

P stock, and a substantial part of the value of the

proprietary interest in T is not preserved. See paragraph (e)(2) of this section.

Example 3. Participation by issuing corporation

in post-merger sale. A owns 80 percent of the T

stock and none of the P stock, which is widely held.

T merges into P. In the merger, A receives P stock.

In addition, A obtains rights pursuant to an arrangement with P to have P register the P stock under the

Securities Act of 1933, as amended. P registers A’s

stock, and A sells the stock shortly after the merger.

No person who purchased the P stock from A is a

person related to P within the meaning of paragraph

(e)(3) of this section. Under paragraphs (e)(1) and

(2) of this section, the sale of the P stock by A is disregarded because no person who purchased the P

stock from A is a person related to P within the

meaning of paragraph (e)(3) of this section. The

transaction satisfies the continuity of interest requirement because A’s T stock was exchanged for P

stock, preserving a substantial part of the value of

the proprietary interest in T.

Example 4. Redemptions and purchases by issuing corporation or related persons. (i) Redemption

by issuing corporation. A owns 100 percent of the

stock of T and none of the stock of P. T merges into

S. In the merger, A receives P stock. In connection

with the merger, P redeems all of the P stock received

by A in the merger for cash. The continuity of interest

requirement is not satisfied, because, in connection

with the merger, P redeemed the stock exchanged for

a proprietary interest in T, and a substantial part of the

value of the proprietary interest in T is not preserved.

See paragraph (e)(1) of this section.

(ii) Purchase of target corporation stock by issuing corporation. The facts are the same as paragraph

(i) of this Example 4, except that, instead of P redeeming its stock, prior to and in connection with the

merger of T into S, P purchases 90 percent of the T

stock from A for cash. The continuity of interest requirement is not satisfied, because in connection with

the merger, P acquired a proprietary interest in T for

consideration other than P stock, and a substantial

part of the value of the proprietary interest in T is not

preserved. See paragraph (e)(1) of this section.

However, see §1.338–2(c)(3) (which may change the

result in this case by providing that, by virtue of section 338, continuity of interest is satisfied for certain

parties after a qualified stock purchase).

(iii) Purchase of issuing corporation stock by

person related to issuing corporation. The facts are

the same as paragraph (i) of this Example 4, except

that, instead of P redeeming its stock, S buys all of

the P stock received by A in the merger for cash. S

is a person related to P under paragraphs (e)(3)(i)(A)

and (B) of this section. The continuity of interest requirement is not satisfied, because S acquired P

stock issued in the merger, and a substantial part of

the value of the proprietary interest in T is not preserved. See paragraph (e)(2) of this section.

Example 5. Redemption in substance by issuing

corporation. A owns 100 percent of the stock of T

and none of the stock of P. T merges into P. In the

merger, A receives P stock. In connection with the

merger, B buys all of the P stock received by A in the

merger for cash. Shortly thereafter, in connection

with the merger, P redeems the stock held by B for

cash. Based on all the facts and circumstances, P in

substance has exchanged solely cash for T stock in

the merger. The continuity of interest requirement is

not satisfied, because in substance P redeemed the

stock exchanged for a proprietary interest in T, and a

substantial part of the value of the proprietary interest in T is not preserved. See paragraph (e)(1) of

this section.

Example 6. Purchase of issuing corporation

stock through partnership. A owns 100 percent of

the stock of T and none of the stock of P. S is an 85

percent partner in PRS. The other 15 percent of PRS

is owned by unrelated persons. T merges into P. In

the merger, A receives P stock. In connection with

the merger, PRS purchases all of the P stock received by A in the merger for cash. Under paragraph

(e)(4) of this section, S, as an 85 percent partner of

PRS, is treated as having acquired 85 percent of the

P stock exchanged for A’s T stock in the merger, and

as having furnished 85 percent of the cash paid by

PRS to acquire the P stock. S is a person related to P

April 6, 1998

under paragraphs (e)(3)(i)(A) and (B) of this section.

The continuity of interest requirement is not satisfied, because S is treated as acquiring 85 percent of

the P stock issued in the merger, and a substantial

part of the value of the proprietary interest in T is not

preserved. See paragraph (e)(2) of this section.

Example 7. Exchange by acquiring corporation

for direct interest. A owns 30 percent of the stock of

T. P owns 70 percent of the stock of T, which was

not acquired by P in connection with the acquisition

of T’s assets. T merges into P. A receives cash in the

merger. The continuity of interest requirement is

satisfied, because P’s 70 percent proprietary interest

in T is exchanged by P for a direct interest in the assets of the target corporation enterprise.

Example 8. Effect of general stock repurchase

program. T merges into P, a corporation whose

stock is widely held and publicly traded and that has

one class of common stock outstanding. In the

merger, T shareholders receive common stock of P.

Immediately after the merger, P repurchases a small

percentage of its common stock in the open market

as part of its ongoing stock repurchase program.

The repurchase program was not created or modified in connection with the acquisition of T. Continuity of interest is satisfied, because based on all of

the facts and circumstances, the redemption of a

small percentage of the P stock does not affect the T

shareholders’ proprietary interest in T, because it

was not in connection with the merger, and the value

of the proprietary interest in T is preserved. See

paragraph (e)(1) of this section.

Example 9. Maintenance of direct or indirect interest in issuing corporation. X, a corporation,

owns all of the stock of each of corporations P and

Z. Z owns all of the stock of T. T merges into P. Z

receives P stock in the merger. Immediately thereafter and in connection with the merger, Z distributes the P stock received in the merger to X. X is a

person related to P under paragraph (e)(3)(i)(A) of

this section. The continuity of interest requirement

is satisfied, because X was an indirect owner of T

prior to the merger who maintains a direct or indirect

proprietary interest in P, preserving a substantial part

of the value of the proprietary interest in T. See

paragraph (e)(2) of this section.

(7) Effective date. This paragraph (e)

applies to transactions occurring after

January 28, 1998, except that it does not

apply to any transaction occurring pursuant to a written agreement which is

binding on January 28, 1998, and at all

times thereafter.

Par. 4. Section 1.368–2 is amended by:

1. Removing the second sentence of

paragraph (a) and adding two sentences in

its place.

2. Removing the second sentence of

paragraph (f) and adding four sentences in

its place.

3. Removing the second sentence in

paragraph (j)(1).

4. Revising paragraph (j)(3)(ii).

5. Revising the first sentence in paragraph (j)(3)(iii).

April 6, 1998

6. Adding paragraph (j)(3)(iv).

7. Removing paragraph (j)(4).

8. Redesignating paragraphs (j)(5),

(j)(6), and (j)(7) as (j)(4), (j)(5), and

(j)(6), respectively.

9. Removing the parentheses around

the numbers in the paragraph headings for

Example (1) through Example (9) in

newly designated paragraph (j)(6).

10. Adding paragraph (k).

The additions and revisions read as follows:

§1.368–2 Definition of terms.

(a) * * * The term does not embrace

the mere purchase by one corporation of

the properties of another corporation. The

preceding sentence applies to transactions

occurring after January 28, 1998, except

that it does not apply to any transaction

occurring pursuant to a written agreement

which is binding on January 28, 1998, and

at all times thereafter. * * *

(f) * * * If a transaction otherwise

qualifies as a reorganization, a corporation

remains a party to the reorganization even

though stock or assets acquired in the reorganization are transferred in a transaction

described in paragraph (k) of this section.

If a transaction otherwise qualifies as a reorganization, a corporation shall not cease

to be a party to the reorganization solely

by reason of the fact that part or all of the

assets acquired in the reorganization are

transferred to a partnership in which the

transferor is a partner if the continuity of

business enterprise requirement is satisfied. See §1.368–1(d). The preceding

three sentences apply to transactions occurring after January 28, 1998, except that

they do not apply to any transaction occurring pursuant to a written agreement

which is binding on January 28, 1998, and

at all times thereafter. * * *

(j) * * *

(3) * * *

(ii) Except as provided in paragraph

(k)(2) of this section, the controlling corporation must control the surviving corporation immediately after the transaction.

(iii) After the transaction, except as

provided in paragraph (k)(2) of this section, the surviving corporation must hold

substantially all of its own properties and

substantially all of the properties of the

merged corporation (other than stock of

the controlling corporation distributed in

the transaction). * * *

(iv) Paragraphs (j)(3)(ii) and (iii) of

this section apply to transactions occurring after January 28, 1998, except that

they do not apply to any transaction occurring pursuant to a written agreement

which is binding on January 28, 1998, and

at all times thereafter.

(k) Transfer of assets or stock in section 368(a)(1)(A), (B), (C), or (G) reorganizations—(1) General rule for transfers

to controlled corporations. Except as

otherwise provided in this section, a

transaction otherwise qualifying under

section 368(a)(1)(A), (B), (C), or (G)

(where the requirements of sections

354(b)(1)(A) and (B) are met) shall not be

disqualified by reason of the fact that part

or all of the acquired assets or stock acquired in the transaction are transferred or

successively transferred to one or more

corporations controlled in each transfer

by the transferor corporation. Control is

defined under section 368(c).

(2) Transfers following a reverse triangular merger. A transaction qualifying

under section 368(a)(1)(A) by reason of

the application of section 368(a)(2)(E) is

not disqualified by reason of the fact that

part or all of the stock of the surviving

corporation is transferred or successively

transferred to one or more corporations

controlled in each transfer by the transferor corporation, or because part or all of

the assets of the surviving corporation or

the merged corporation are transferred or

successively transferred to one or more

corporations controlled in each transfer

by the transferor corporation.

(3) Examples. The following examples illustrate the application of this paragraph (k). P is the issuing corporation and

T is the target corporation. P has only one

class of stock outstanding. The examples

are as follows:

Example 1. Transfers of acquired assets to controlled corporations. (i) Facts. T operates a bakery

which supplies delectable pastries and cookies to

local retail stores. The acquiring corporate group

produces a variety of baked goods for nationwide

distribution. P owns 80 percent of the stock of S–1.

Pursuant to a plan of reorganization, T transfers all

of its assets to S–1 solely in exchange for P stock,

which T distributes to its shareholders. S–1 owns 80

1998–14 I.R.B.

percent of the stock of S–2; S–2 owns 80 percent of

the stock of S–, which also makes and supplies pastries and cookies. Pursuant to the plan of reorganization, S–1 transfers the T assets to S–2; S–2 transfers the T assets to S–3.

(ii) Analysis. Under this paragraph (k), the transaction, otherwise qualifying as a reorganization

under section 368(a)(1)(C), is not disqualified by

reason of the fact of the successive transfers of all of

the acquired assets from S–1 to S–2, and from S–2

to S–3 because in each transfer, the transferee corporation is controlled by the transferor corporation.

Control is defined under section 368(c).

Example 2. Transfers of acquired stock to controlled corporations. (i) Facts. The facts are the

same as Example 1 except that S–1 acquires all of the

T stock rather than the T assets, and as part of the plan

of reorganization, S–1 transfers all of the T stock to

S–2, and S–2 transfers all of the T stock to S–3.

(ii) Analysis. Under this paragraph (k), the transaction, otherwise qualifying as a reorganization

under section 368(a)(1)(B), is not disqualified by

reason of the fact of the successive transfers of all of

S–2, and from S–2 to S–3 because in each transfer,

the transferee corporation is controlled by the transferor corporation.

Example 3. Transfers of acquired stock to partnerships. (i) Facts. The facts are the same as in Example 2. However, as part of the plan of reorganization, S–2 and S–3 form a new partnership, PRS.

Immediately thereafter, S–3 transfers all of the T

stock to PRS in exchange for an 80 percent partnership interest, and S–2 transfers cash to PRS in exchange for a 20 percent partnership interest.

(ii) Analysis. This paragraph (k) describes the

successive transfer of the T stock to S–3, but does

not describe S–3’s transfer of the T stock to PRS.

Therefore, the characterization of this transaction

must be determined under the relevant provisions of

law, including the step transaction doctrine. See

§1.368–1(a). The transaction fails to meet the control requirement of a reorganization described in

section 368(a)(1)(B) because immediately after the

acquisition of the T stock, the acquiring corporation

does not have control of T.

(4) This paragraph (k) applies to transactions occurring after January 28, 1998,

except that it does not apply to any transaction occurring pursuant to a written

agreement which is binding on January

28, 1998, and at all times thereafter.

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

Approved January 12, 1998.

Donald C. Lubick,

Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

January 23, 1998, 12:15 p.m., and published in the

issue of the Federal Register for January 28, 1998,

63 F.R. 4174)

1998–14 I.R.B.

26 CFR 1.368–1T: Purpose and scope of exception

of reorganization exchanges (temporary).

T.D. 8761

tential reorganization, an extraordinary

distribution is made with respect to it.

Background

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Continuity of Interest

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains

temporary regulations providing guidance

regarding satisfaction of the continuity of

interest requirement for corporate reorganizations. The temporary regulations affect corporations and their shareholders.

Final regulations published in T.D. 8760,

page 4 of this Bulletin, also provide guidance regarding satisfaction of the continuity of interest requirement for corporate

reorganizations. These temporary regulations amplify the final regulations. The

text of these temporary regulations also

serves as the text of proposed regulations

published in REG–120882–97, page 25 of

this Bulletin.

DATES: These regulations are effective

January 28, 1998.

Applicability: These regulations apply

to transactions occurring after January 28,

1998, except that they do not apply to any

transaction occurring pursuant to a written agreement which is (subject to customary conditions) binding on January

28, 1998, and at all times thereafter.

FOR FURTHER INFORMATION CONTACT: Phoebe Bennett, (202) 622-7750

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

This document contains amendments to

the Income Tax Regulations (26 CFR part

1) under section 368. These temporary

regulations provide that, in determining

whether the continuity of interest requirement for corporate reorganizations is satisfied with respect to a potential reorganization, a proprietary interest in the target

corporation is not preserved if, in connection with a potential reorganization, it is

redeemed or acquired by a person related

to the target corporation, or to the extent

that, prior to and in connection with a po-

On December 23, 1996, the IRS published a notice of proposed rulemaking

(REG–252231–96 [1997–1 C.B. 800]) in

the Federal Register (61 F.R. 67512) relating to the continuity of interest requirement. Many written comments were received in response to this notice of

proposed rulemaking. A public hearing

on the proposed regulations was held on

May 7, 1997. After consideration of all

comments, the regulations proposed by

REG–252231–96 are adopted as final regulations, and published in T.D. 8760.

These temporary regulations supplement

the final regulations.

Explanation of Provisions

Final regulations published in T.D.

8760 provide that in determining whether

the continuity of interest (COI) requirement for corporate reorganizations is satisfied, dispositions of stock of the target

corporation (T) by a T shareholder generally are not taken into account.

Redemptions of T Stock or Extraordinary

Distributions with Respect to T Stock

Commentators requested guidance on

the circumstances under which a redemption by T of its stock would adversely affect satisfaction of the COI requirement.

Some commentators suggested that the

IRS and Treasury Department adopt an

approach that would identify either the issuing corporation (P) or T as the source of

the funds for the redemption. If, in connection with an acquisition of T, the facts

and circumstances indicate that P did not

directly or indirectly furnish funds used

by T to redeem T shareholders, these

commentators suggested that satisfaction

of the COI requirement should not be adversely affected. In many transactions,

however, such a tracing approach would

be extremely difficult to administer. For

example, if P acquired the assets, rather

than the stock, of T or if T redeemed stock

for a note, it would be unclear in many

circumstances whether in substance T or

P assets were used to fund the redemption

or to repay the note.

Another commentator suggested that

redemptions by T in connection with a

April 6, 1998

potential reorganization should adversely

affect satisfaction of the COI requirement

because the effect on COI is the same as if

P had furnished the redemption consideration in the transaction. The temporary

regulations generally adopt this approach

because it reflects that T and P will be

combined economically and because of

the difficulties of administering a tracing

approach, as previously described.

Treatment of stock redeemed by T as

proprietary interests that are not preserved

in the reorganization also accords the

same tax result to transactions that reach

the same result by different steps. For example, T could merge into P for a combination of consideration, of which 30 percent is P stock and 70 percent is a P

promissory note. Conversely, T could

issue its promissory note to redeem 70

percent of the T stock and then P would

assume the T note in the merger, in which

the remaining T shareholders receive

solely P stock. From the perspective of P,

T, and the T shareholders, these two transactions are substantively identical, and the

COI requirement is not satisfied in the first

transaction. The temporary regulations

provide that the second transaction likewise does not satisfy the COI requirement.

In addition, this approach corresponds

with the rule of the final regulations that a

proprietary interest in T is not preserved if,

in connection with the potential reorganization, P stock furnished in exchange for a

proprietary interest in T in the potential reorganization is redeemed. Because the

final regulations do not inquire, in the case

of a subsequent P redemption, whether the

source of consideration furnished in the

redemption was former T assets or historic

P assets, the temporary regulations similarly do not make an inquiry in the case of

a prior T redemption. Instead, for purposes of the COI requirement, the temporary regulations treat T and P as a combined economic enterprise. In an asset

acquisition, this approach avoids the difficult process of identifying the source of

payments as between T and P.

Commentators have suggested that this

approach is inconsistent with authorities

which hold that redemptions of stock of

the target corporation with assets of the

target corporation do not violate the

solely-for-voting-stock requirement applicable to section 368(a)(1)(B) reorganizations. See, e.g., Rev. Rul. 55–440

April 6, 1998

(1955–2 C.B. 226). None of these authorities address the effect on continuity of interest of such redemptions. For the reasons stated above, the temporary

regulations take such redemptions into account for continuity purposes.

The temporary regulations provide that

a proprietary interest in T is not preserved

if, in connection with a potential reorganization, it is redeemed or to the extent that,

prior to and in connection with a potential

reorganization, an extraordinary distribution is made with respect to it. An extraordinary distribution with respect to T

stock, followed by a sale of the remaining

T stock to P, has the same effect on the

value of the proprietary interest in T as a

pro rata redemption by T followed by a

sale of the outstanding T stock to P.

The temporary regulations do not provide guidance on the determination of

whether a distribution will be treated as

an extraordinary distribution, except that

the rules of section 1059 do not apply for

this purpose. The IRS and Treasury Department invite comments on whether the

regulations should provide more specific

guidance in this area.

A section 355 distribution of controlled

corporation stock by T will preserve a

proprietary interest in T, except to the extent that the T shareholders receive other

property or money to which section

356(a) applies or the distribution is extraordinary in amount and is a distribution of

property or money to which section

356(b) applies.

Related Person Rule

In determining whether the COI requirement is satisfied, dispositions of T

stock to persons that are not related to T

or P are disregarded. The final regulations provide that a proprietary interest in

T is not preserved if, in connection with a

potential reorganization, a person related

to P acquires, with consideration other

than a proprietary interest in P, T stock or

P stock furnished in exchange for a proprietary interest in T in the potential reorganization. Consistent with the final regulations, the temporary regulations

provide that a proprietary interest in T is

not preserved if, prior to and in connection with a potential reorganization, a person related to T acquires T stock with

consideration other than T stock or P

stock.

Definition of Related Person of T

The final regulations include as related

persons any corporation that is a member

of the affiliated group, within the meaning

of section 1504, of which P is a member,

and any corporation whose purchase of P

stock would be treated as a redemption of

that stock under section 304(a)(2). The

section 1504 test was adopted because the

IRS and Treasury Department were concerned that acquisitions of T stock or P

stock by P affiliated corporations were no

different in substance than acquisitions or

redemptions by P. This concern does not

generally extend to members of T’s affiliated group that are not also considered related to T under section 304(a)(2) because

such corporations are T shareholders participating in the potential reorganization

along with the other shareholders of the

target corporation. The temporary regulations treat two corporations as related persons if a purchase of the stock of one corporation by another corporation would be

treated as a distribution in redemption of

the stock of the first corporation under

section 304(a)(2) (determined without regard to §1.1502–80(b)).

Effect on Other Authorities

These COI regulations apply solely for

purposes of determining whether the COI

requirement is satisfied. No inference

should be drawn from any provision of

this regulation as to whether other reorganization requirements are satisfied, or as

to the characterization of a related transaction. See, e.g., §1.301–1(l).

Effect on Other Documents

Rev. Proc. 77–37 (1977–2 C.B. 568)

and Rev. Proc. 86–42 (1986–2 C.B. 722)

will be modified to the extent inconsistent

with these temporary regulations.

Effective Date

These regulations apply to transactions

occurring after January 28, 1998, except

that they do not apply to any transaction

occurring pursuant to a written agreement

which is (subject to customary conditions) binding on January 28, 1998, and at

all times thereafter.

Special Analyses

It has been determined that these temporary regulations are not a significant

1998–14 I.R.B.

regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not

apply to these temporary regulations and,

because the temporary regulations do not

impose a collection of information on

small entities, the Regulatory Flexibility

Act (5 U.S.C. chapter 6) does not apply.

Therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue

Code, these regulations will be submitted

to the Chief Counsel for Advocacy of the

Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Phoebe Bennett of the Office of

the Assistant Chief Counsel (Corporate),

IRS. However, other personnel from the

IRS and Treasury Department participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is amended

as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.368–1T is added to

read as follows:

§1.368–T Purpose and scope of exception

of reorganization exchanges (temporary).

(a) through (e)(1)(i) [Reserved] For

further guidance see §1.368–1(a) through

(e)(1)(i).

(e)(1)(ii)(A) General rule. A proprietary interest in the target corporation

(other than one held by the acquiring corporation) is not preserved if, prior to and

in connection with a potential reorganization, it is redeemed or to the extent that,

prior to and in connection with a potential

reorganization, an extraordinary distribution is made with respect to it. The determination of whether a distribution with

respect to stock of the target corporation

is an extraordinary distribution for pur-

1998–14 I.R.B.

poses of this paragraph (e)(1)(ii) will be

made on the basis of all of the facts and

circumstances, but the treatment of the

distribution under section 1059 (relating

to extraordinary dividends) will not be

taken into account.

(B) Exception. Paragraph (e)(1)(ii)(A)

of this section does not apply to a distribution of stock by the target corporation to

which section 355(a) (or so much of section 356 as relates to section 355) applies,

except to the extent that—

(1) The target corporation shareholders

receive other property or money to which

section 356(a) applies; or

(2) The distribution is extraordinary in

amount and is a distribution of property or

money to which section 356(b) applies.

(2)(i) [Reserved] For further guidance, see §1.368–1(e)(2)(i).

(ii) A proprietary interest in the target

corporation is not preserved if, prior to

and in connection with a potential reorganization, a person related (as defined in

§1.368–1(e)(3) determined without regard to §1.368–1(e)(3)(i)(A)) to the target

corporation acquires stock of the target

corporation, with consideration other than

stock of either the target corporation or

the issuing corporation.

(e)(3) through (e)(6) Example 9. [Reserved] For further guidance, see §1.3681(e)(3) through (e)(6) Example 9.

(e)(6) Example 10. Acquisition of target corporation stock before merger. (i) Redemption by target

corporation. A owns 85 percent and B owns 15 percent of the stock of T. The fair market value of T is

$100x. Neither A nor B own stock of P. Prior to and

in connection with the merger of T into P, T redeems

A’s T stock for $85x and issues to A its promissory

note in exchange for the stock. At the time of the

merger T has a value of $15x, after giving effect to

the redemption of its stock. In the merger, B receives solely P stock. The continuity of interest requirement is not satisfied because T redeemed A’s

stock, and a substantial part of the value of the proprietary interest in T is not preserved. See paragraph

(e)(1)(ii)(A) of this section.

(ii) Purchase by person related to target corporation. The facts are the same as paragraph (i) of

this Example 10, except that X, T’s wholly owned

subsidiary, acquires A’s T stock prior to and in connection with the merger for cash of $85x. Under

paragraph (e)(2)(ii) of this section and §1.368–

1(e)(3)(i)(B), X’s acquisition of A’s T stock is an acquisition by a related person. The continuity of interest requirement is not satisfied, because X acquired T stock, for consideration other than P stock,

and a substantial part of the value of the proprietary

interest in T is not preserved. See paragraph

(e)(2)(ii) of this section.

Example 11. Extraordinary distribution before

merger. A owns all of the stock of T. The fair mar-

ket value of T is $100x. Prior to and in connection

with the merger of T into P, T pays A an extraordinary distribution of an $85x note. T merges into P,

and A receives solely P stock. P assumes T’s obligation on the note. The continuity of interest requirement is not satisfied, because T paid A an extraordinary distribution, and a substantial part of the value

of the proprietary interest in T is not preserved. See

paragraph (e)(1)(ii)(A) of this section.

(f) Effective date. This section applies

to transactions occurring after January 28,

1998, except that it does not apply to any

transaction occurring pursuant to a written agreement which is (subject to customary conditions) binding on January

28, 1998, and at all times thereafter.

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

Approved January 12, 1998.

Donald C. Lubick,

Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

January 23, 1998, 12:15 p.m., and published in the

issue of the Federal Register for January 28, 1998,

63 F.R. 4183)

Section 382.—Limitation on Net

Operating Loss Carryforwards

and Certain Built-In Losses

Following Ownership Change

The adjusted federal long-term rate is set forth

for the month of April 1998. See Rev. Rul. 98–18,

page 22.

Section 412.—Minimum Funding

Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

Section 453.—Installment

Method

26 CFR 1.453–11: Installment obligations received

from a liquidation corporation.

T.D. 8762

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

April 6, 1998

Installment Obligations Received

From Liquidating Corporations

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to the use of the

installment method to report the gain recognized by a shareholder who receives, in

exchange for the shareholder’s stock, certain installment obligations that are distributed upon the complete liquidation of

a corporation. Changes to the applicable

tax law were made by the Installment

Sales Revision Act of 1980 and the Tax

Reform Act of 1986. These regulations

affect taxpayers who receive installment

obligations in exchange for their stock

upon the complete liquidation of a corporation.

DATES: This regulation is effective January 28, 1998.

For dates of applicability, see §1.453–

11(e) of these regulations.

FOR FURTHER INFORMATION CONTACT: George F. Wright, (202) 622-4950

(not a toll-free number).

SUPPLEMENTARY INFORMATION

Background

Section 453(h), relating to the tax treatment of installment obligations received

by a shareholder from a liquidating corporation, was added to the Internal Revenue

Code of 1954 by the Installment Sales Revision Act of 1980, Public Law 96–471,

94 Stat. 2247, 2250. Proposed regulations under section 453(h) were published

in the Federal Register for January 13,

1984 (49 F.R. 1742). Subsequently, section 453(h) was amended as part of the

Tax Reform Act of 1986, Public Law 99514, 100 Stat. 2085, 2274, pursuant to

which both C and S corporations became

subject to tax upon making liquidating

distributions of installment obligations to

shareholders. The Technical and Miscellaneous Revenue Act of 1988, Public Law

100–647, 102 Stat. 3342, 3403, added

section 453B(h), which provides that no

gain or loss is recognized by S corporations with respect to certain liquidating

distributions of installment obligations.

The regulations proposed on January 13,

April 6, 1998

1984 (49 F.R. 1742), were withdrawn by

the notice of proposed rulemaking published on January 22, 1997 (62 F.R.

3244), except for paragraph (e) relating to

liquidating distributions received in more

than one taxable year, and paragraph (g)

containing the effective date provision.

The notice of proposed rulemaking published in the Federal Register for January 22, 1997, reserved paragraph (d) for

liquidating distributions received in more

than one taxable year. Written comments

responding to this notice were received.

No public hearing was held because no

hearing was requested. After consideration of all comments received, the proposed regulations are adopted as revised

by this Treasury decision.

Explanation of Provisions

A. Overview of Provisions

Prior to the Installment Sales Revision

Act of 1980, a shareholder recognized

gain or loss on receipt of an installment

obligation that was distributed by a liquidating corporation in exchange for the

shareholder’s stock. Gain could not be reported under the installment sale provisions of section 453 as payments were received on the obligation distributed by the

corporation in the liquidation.

As enacted by the Installment Sales Revision Act of 1980 and amended by the

Tax Reform Act of 1986, section 453(h)

provides a different treatment for certain

installment obligations that are distributed

in a complete liquidation to which section

331 applies. Under section 453(h), a

shareholder that does not elect out of the

installment method treats the payments

under the obligation, rather than the

obligation itself, as consideration received in exchange for the stock. The

shareholder then takes into account the income from the payments under the obligation using the installment method. In

this manner, the shareholder generally is

treated as if the shareholder sold the

shareholder’s stock to an unrelated purchaser on the installment method.

This treatment under section 453(h) applies generally to installment obligations

received by a shareholder (in exchange

for the shareholder’s stock) in a complete

liquidation to which section 331 applies if

(a) the installment obligations are qualifying installment obligations, i.e., the installment obligations are acquired in re-

spect of a sale or exchange of property by

the corporation during the 12-month period beginning on the date a plan of complete liquidation is adopted, and (b) the

liquidation is completed within that 12month period. However, an installment

obligation acquired in a sale or exchange

of inventory, stock in trade, or property

held for sale in the ordinary course of

business qualifies for this treatment only

if the obligation arises from a single bulk

sale of substantially all of such property

attributable to a trade or business of the

corporation. If an installment obligation

arises from both a sale or exchange of inventory, etc., that does not comply with

the requirements of the preceding sentence and a sale or exchange of other assets, the portion of the installment obligation that is attributable to the sale or

exchange of other assets is a qualifying

installment obligation.

B. Discussion of Comments

Interaction of section 453(h) and

limitations on the installment method

The regulations provide that, if the stock

of a liquidating corporation is traded on an

established securities market, an installment obligation received by a shareholder

from that corporation as a liquidating distribution is not a qualifying installment

obligation and does not qualify for installment reporting, regardless of whether the

requirements of section 453(h) are otherwise satisfied. However, if an installment

obligation is received by a shareholder

from a liquidating corporation whose stock

is not publicly traded, and the obligation

arose from a sale by the corporation of

stock or securities that are traded on an established market, then the obligation generally is a qualifying installment obligation

in the hands of the transferor. An exception to the above rule applies if the liquidating corporation is formed or availed of

for a principal purpose of avoiding limitations on the availability of installment sales

treatment, such as section 453(k), through

the use of a related party.

One commentator suggested that the

anti-abuse rule directed at cases in which

there is a principal purpose to avoid section 453(k) is not necessary. The commentator suggests that the effect of a contribution of publicly-traded stock to a

nonpublicly-traded corporation, followed

1998–14 I.R.B.

by the sale of the publicly-traded stock for

an installment obligation and the liquidation of the nonpublicly-traded corporation, is the creation of two levels of tax

because the liquidating corporation must

recognize gain on the distribution of the

installment obligation. Accordingly, the

commentator does not believe that the

transaction offers any tax avoidance opportunities that warrant a specific antiabuse rule.

The anti-abuse rule is directed at circumvention of the prohibition in section

453(k) against the use of the installment

method for a sale of publicly-traded securities. It is designed to prevent a shareholder from indirectly entering into such a

sale on the installment method when the

shareholder could not have done so

through a direct sale. Accordingly, the

anti-abuse rule has been retained.

Liquidating distributions received in

more than one year

Under §1.453–2(e) proposed on January 13, 1984, if liquidating distributions,

including qualifying installment obligations, are received in more than one taxable year, a shareholder must file an

amended return if the reallocation of basis

required under section 453(h)(2) affects

the computation of gain recognized in an

earlier year. If the shareholder has transferred the installment obligation to a person whose basis in the obligation is determined by reference to the shareholder’s

basis, then the transferee generally is

required to reallocate basis and, if necessary, file an amended return. The proposed effective date applied to distributions of qualifying installment obligations

made after March 31, 1980.

In the preamble to the 1997 proposed

regulations, the IRS and Treasury Department suggested that an alternative to the

amended return requirement would be to

require the shareholder to recognize in the

current year the additional amount of gain

that would have been recognized in the

earlier year had the total amount of the

liquidating distributions been known in

the earlier year. Comments were requested regarding these and any other

methods of accomplishing the basis reallocation. Proposed §1.453–11(d) relating

to liquidating distributions received in

more than one taxable year was reserved.

One commentator questioned whether

1998–14 I.R.B.

amended returns were necessary and

noted that the alternative method discussed in the preamble is simpler and less

burdensome for taxpayers. The commentator then suggested an ordering rule as

another method of achieving the intended

purpose. Under the proposed ordering

rule, basis first would be allocated to assets other than installment obligations distributed in the liquidation with the remainder allocated to the installment

obligations. The commentator acknowledged that it might not be appropriate to

implement this approach by regulation

without amending the statute.

The proposed ordering rule does not

satisfy the basis reallocation requirement

of section 453(h)(2) and would require

complex provisions to implement it. Accordingly, the suggested approach is not

adopted in the final regulations.

The purpose underlying section 453(h)(2) is to ensure that gain is recognized in

the appropriate year when liquidating distributions are received in more than one

taxable year. The IRS and Treasury Department believe that this purpose can be

substantially fulfilled without imposing

the burden of filing amended returns. Accordingly, the final regulations incorporate

a current-year recognition rule. Under the

current-year recognition rule, a shareholder is required to recognize in the current year the additional amount of gain

that would have been recognized in the

earlier year had the total amount of the liquidating distributions been known in the

earlier year. In allocating basis to calculate the gain to be reported in the first year

in which a liquidating distribution is received, a shareholder is required to reasonably estimate the anticipated aggregate

distributions. For this purpose, the shareholder must take into account distributions

and other events occurring up to the time

at which the return for the first taxable

year is filed. Section §1.453–2(e) of the

1984 proposal is adopted as revised by

this Treasury decision. The effective date

provision in §1.453–2(g) of the proposal is

not adopted.

Recognition of gain or loss to the

distributing corporation under section

453B

Under section 453B, the disposition of

an installment obligation generally results

in the recognition of gain or loss to the

transferor. Thus, in accordance with sections 453B and 336, a C corporation generally recognizes gain or loss upon the

distribution of an installment obligation to

a shareholder in exchange for the shareholder’s stock, including complete liquidations covered by section 453(h). Section 453B(d) provides an exception to this

general rule if the installment obligation

is distributed in a liquidation to which

section 337(a) applies (regarding certain

complete liquidations of 80 percent or

more owned subsidiaries). However, that

exception does not apply to liquidations

under section 331.

In the case of a liquidating distribution

by an S corporation, however, section

453B(h) provides that if an S corporation

distributes an installment obligation in exchange for a shareholder’s stock, and payments under the obligation are treated as

consideration for the stock pursuant to

section 453(h)(1), then the distribution

generally is not treated as a disposition of

the obligation by the S corporation. Thus,

except for purposes of sections 1374 and

1375 (relating to certain built-in gains and

passive investment income), the S corporation does not recognize gain or loss on

the distribution of the installment obligation to a shareholder in a complete liquidation covered by section 453(h). One commentator believed that it is inequitable to

allow a shareholder to recognize gain on

the installment basis while the liquidating

C corporation has immediate recognition

upon distribution of an obligation. As an

alternative, the commentator suggested

that the corporation’s tax liability arising

from the distribution of an obligation carry

over to the shareholders and be taken into

account by them as payments are received

on the obligation. The suggested approach would be inconsistent with the

statutory provisions of sections 336 and

453B and, accordingly, is not adopted in

the final regulations.

Another commentator requested that

the regulations provide relief from a

bunching of income that occurs for shareholders receiving liquidating distributions

from S corporations. The bunching can

occur, for example, by virtue of the interrelationship of the S corporation and installment sale provisions if, in the year in

which assets are sold, an S corporation receives a payment on an installment obligation arising from the sale before the cor-

April 6, 1998

poration liquidates. The commentator

suggested that the regulations allow a

shareholder first to apply the basis in the

stock against the initial payment received,

with any remaining basis allocated to any

additional payments to be received. Since

the bunching of income results from the

successive application of section 453(c) at

the corporate and shareholder levels and

no statutory exception for shareholders of

S corporations is provided, this issue cannot be appropriately addressed in these

final regulations.

Incorporation of guidance on section

338(h)(10) elections

Three commentators suggested that the

regulations be expanded to address the

use of the installment method to the sale

of stock of a corporation with respect to

which an election under section

338(h)(10) has been made. This issue

does not arise under section 453(h) and is

beyond the scope of these regulations.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not

apply to these regulations, and because

the regulations do not impose a collection

of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter

6) does not apply. Pursuant to section

7805(f) of the Internal Revenue Code, the

notice of proposed rulemaking preceding

these regulations was submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment on

its impact on small business.

Drafting Information

The principal author of these regulations is George F. Wright of the Office of

Assistant Chief Counsel (Income Tax and

Accounting). However, other personnel

from the IRS and Treasury Department

participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is amended

as follows:

April 6, 1998

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding an entry in

numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

§1.453–11 also issued under 26 U.S.C.

453(j)(1) and (k). * * *

Par. 2. Section 1.453–11 is added to

read as follows:

§1.453–11 Installment obligations

received from a liquidating corporation.

(a) In general—(1) Overview. Except

as provided in section 453(h)(1)(C) (relating to installment sales of depreciable

property to certain closely related persons), a qualifying shareholder (as defined in paragraph (b) of this section) who

receives a qualifying installment obligation (as defined in paragraph (c) of this

section) in a liquidation that satisfies section 453(h)(1)(A) treats the receipt of

payments in respect of the obligation,

rather than the receipt of the obligation itself, as a receipt of payment for the shareholder’s stock. The shareholder reports

the payments received on the installment

method unless the shareholder elects otherwise in accordance with §15a.453–1(d)

of this chapter.

(2)

Coordination with other

provisions—(i) Deemed sale of stock for

installment obligation. Except as specifically provided in section 453(h)(1)(C), a

qualifying shareholder treats a qualifying

installment obligation, for all purposes of

the Internal Revenue Code, as if the obligation is received by the shareholder from

the person issuing the obligation in exchange for the shareholder’s stock in the

liquidating corporation. For example, if

the stock of a corporation that is liquidating is traded on an established securities

market, an installment obligation distributed to a shareholder of the corporation in

exchange for the shareholder’s stock does

not qualify for installment reporting pursuant to section 453(k)(2).

(ii) Special rules to account for the

qualifying installment obligation—(A)

Issue price. A qualifying installment

obligation is treated by a qualifying shareholder as newly issued on the date of the

distribution. The issue price of the qualifying installment obligation on that date is

equal to the sum of the adjusted issue

price of the obligation on the date of the

distribution (as determined under

§1.1275–1(b)) and the amount of any

qualified stated interest (as defined in

§1.1273–1(c)) that has accrued prior to

the distribution but that is not payable

until after the distribution. For purposes

of the preceding sentence, if the qualifying installment obligation is subject to

§1.446–2 (e.g., a debt instrument that has

unstated interest under section 483), the

adjusted issue price of the obligation is

determined under §1.446–2(c) and (d).

(B) Variable rate debt instrument. If

the qualifying installment obligation is a

variable rate debt instrument (as defined

in §1.1275–5), the shareholder uses the

equivalent fixed rate debt instrument

(within the meaning of §1.1275–5(e)(3)(ii)) constructed for the qualifying installment obligation as of the date the

obligation was issued to the liquidating

corporation to determine the accruals of

original issue discount, if any, and interest

on the obligation.

(3) Liquidating distributions treated as

selling price. All amounts distributed or

treated as distributed to a qualifying

shareholder incident to the liquidation, including cash, the issue price of qualifying

installment obligations as determined

under paragraph (a)(2)(ii)(A) of this section, and the fair market value of other

property (including obligations that are

not qualifying installment obligations) are

considered as having been received by the

shareholder as the selling price (as defined in §15a.453–1(b)(2)(ii) of this chapter) for the shareholder’s stock in the liquidating corporation. For the proper

method of reporting liquidating distributions received in more than one taxable

year of a shareholder, see paragraph (d) of

this section. An election not to report on

the installment method an installment

obligation received in the liquidation applies to all distributions received in the

liquidation.

(4) Assumption of corporate liability by

shareholders. For purposes of this section, if in the course of a liquidation a

shareholder assumes secured or unsecured

liabilities of the liquidating corporation, or

receives property from the corporation

subject to such liabilities (including any

tax liabilities incurred by the corporation

on the distribution), the amount of the liabilities is added to the shareholder’s basis

in the stock of the liquidating corporation.

1998–14 I.R.B.

These additions to basis do not affect the

shareholder ’s holding period for the

stock. These liabilities do not reduce the

amounts received in computing the selling price.

(5) Examples. The provisions of this

paragraph (a) are illustrated by the following examples. Except as otherwise provided, assume in each example that A, an

individual who is a calendar-year taxpayer,

owns all of the stock of T corporation. A’s

adjusted tax basis in that stock is $100,000.

On February 1, 1998, T, an accrual method

taxpayer, adopts a plan of complete liquidation that satisfies section 453(h)(1)(A)

and immediately sells all of its assets to unrelated B corporation in a single transaction. The examples are as follows:

Example 1. (i) The stated purchase price for T’s

assets is $3,500,000. In consideration for the sale, B

makes a down payment of $500,000 and issues a 10year installment obligation with a stated principal

amount of $3,000,000. The obligation provides for

interest payments of $150,000 on January 31 of each

year, with the total principal amount due at maturity.

(ii) Assume that for purposes of section 1274, the

test rate on February 1, 1998, is 8 percent, compounded semi-annually. Also assume that a semiannual accrual period is used. Under §1.1274–2, the

issue price of the obligation on February 1, 1998, is

$2,368,450. Accordingly, the obligation has

$631,550 of original issue discount ($3,000,000 –

$2,368,450). Between February 1 and July 31,

$19,738 of original issue discount and $75,000 of

qualified stated interest accrue with respect to the

obligation and are taken into account by T.

(iii) On July 31, 1998, T distributes the installment obligation to A in exchange for A’s stock. No

other property is ever distributed to A. On January

31, 1999, A receives the first annual payment of

$150,000 from B.

(iv) When the obligation is distributed to A on

July 31, 1998, it is treated as if the obligation is received by A in an installment sale of shares directly

to B on that date. Under §1.1275–1(b), the adjusted

issue price of the obligation on that date is

$2,388,188 (original issue price of $2,368,450 plus

accrued original issue discount of $19,738). Accordingly, the issue price of the obligation under

paragraph (a)(2)(ii)(A) of this section is $2,463,188,

the sum of the adjusted issue price of the obligation

on that date ($2,388,188) and the amount of accrued

but unpaid qualified stated interest ($75,000).

(v) The selling price and contract price of A’s

stock in T is $2,463,188, and the gross profit is

$2,363,188 ($2,463,188 selling price less A’s adjusted tax basis of $100,000). A’s gross profit ratio

is thus 96 percent (gross profit of $2,363,188 divided by total contract price of $2,463,188).

(vi) Under §§1.446–2(e)(1) and 1.1275–2(a),

$98,527 of the $150,000 payment is treated as a payment of the interest and original issue discount that

accrued on the obligation from July 31, 1998, to January 31, 1999 ($75,000 of qualified stated interest

and $23,527 of original issue discount). The balance

of the payment ($51,473) is treated as a payment of

1998–14 I.R.B.

principal. A’s gain recognized in 1999 is $49,414

(96 percent of $51,473).

Example 2. (i) T owns Blackacre, unimproved

real property, with an adjusted tax basis of $700,000.

Blackacre is subject to a mortgage (underlying mortgage) of $1,100,000. A is not personally liable on

the underlying mortgage and the T shares held by A

are not encumbered by the underlying mortgage.

The other assets of T consist of $400,000 of cash

and $600,000 of accounts receivable attributable to

sales of inventory in the ordinary course of business.

The unsecured liabilities of T total $900,000.

(ii) On February 1, 1998, T adopts a plan of complete liquidation complying with section

453(h)(1)(A), and promptly sells Blackacre to B for

a 4-year mortgage note (bearing adequate stated interest and otherwise meeting all of the requirements

of section 453) in the face amount of $4 million.

Under the agreement between T and B, T (or its successor) is to continue to make principal and interest

payments on the underlying mortgage. Immediately

thereafter, T completes its liquidation by distributing

to A its remaining cash of $400,000 (after payment

of T’s tax liabilities), accounts receivable of

$600,000, and the $4 million B note. A assumes T’s

$900,000 of unsecured liabilities and receives the

distributed property subject to the obligation to

make payments on the $1,100,000 underlying mortgage. A receives no payments from B on the B note

during 1998.

(iii) Unless A elects otherwise, the transaction is

reported by A on the installment method. The selling price is $5 million (cash of $400,000, accounts

receivable of $600,000, and the B note of $4 million). The total contract price also is $5 million. A’s

adjusted tax basis in the T shares, initially $100,000,

is increased by the $900,000 of unsecured T liabilities assumed by A and by the obligation (subject to

which A takes the distributed property) to make payments on the $1,100,000 underlying mortgage on

Blackacre, for an aggregate adjusted tax basis of

$2,100,000. Accordingly, the gross profit is

$2,900,000 (selling price of $5 million less aggregate adjusted tax basis of $2,100,000). The gross

profit ratio is 58 percent (gross profit of $2,900,000

divided by the total contract price of $5 million).

The 1998 payments to A are $1 million ($400,000

cash plus $600,000 receivables) and A recognizes

gain in 1998 of $580,000 (58 percent of $1 million).

(iv) In 1999, A receives payment from B on the B

note of $1 million (exclusive of interest). A’s gain

recognized in 1999 is $580,000 (58 percent of $1

million).

(b) Qualifying shareholder. For purposes of this section, qualifying shareholder means a shareholder to which,

with respect to the liquidating distribution, section 331 applies. For example, a

creditor that receives a distribution from a

liquidating corporation, in exchange for

the creditor’s claim, is not a qualifying

shareholder as a result of that distribution

regardless of whether the liquidation satisfies section 453(h)(1)(A).

(1) In general. For purposes of this sec-

tion, qualifying installment obligation

means an installment obligation (other

than an evidence of indebtedness described in §15a.453–1(e) of this chapter,

relating to obligations that are payable on

demand or are readily tradable) acquired

in a sale or exchange of corporate assets

by a liquidating corporation during the

12-month period beginning on the date

the plan of liquidation is adopted. See

paragraph (c)(4) of this section for an exception for installment obligations acquired in respect of certain sales of inventory. Also see paragraph (c)(5) of this

section for an exception for installment

obligations attributable to sales of certain

property that do not generally qualify for

installment method treatment.

(2) Corporate assets. Except as provided in section 453(h)(1)(C), in paragraph (c)(4) of this section (relating to

certain sales of inventory), and in paragraph (c)(5) of this section (relating to

certain tax avoidance transactions), the

nature of the assets sold by, and the tax

consequences to, the selling corporation

do not affect whether an installment

obligation is a qualifying installment

obligation. Thus, for example, the fact

that the fair market value of an asset is

less than the adjusted basis of that asset

in the hands of the corporation; or that

the sale of an asset will subject the corporation to depreciation recapture (e.g.,

under section 1245 or section 1250); or

that the assets of a trade or business sold

by the corporation for an installment

obligation include depreciable property,

certain marketable securities, accounts

receivable, installment obligations, or

cash; or that the distribution of assets to

the shareholder is or is not taxable to the

corporation under sections 336 and 453B,

does not affect whether installment obligations received in exchange for those assets are treated as qualifying installment

obligations by the shareholder. However,

an obligation received by the corporation

in exchange for cash, in a transaction unrelated to a sale or exchange of noncash

assets by the corporation, is not treated as

a qualifying installment obligation.

(3) Installment obligations distributed

in liquidations described in section

453(h)(1)(E)—(i) In general. In the case

of a liquidation to which section

453(h)(1)(E) (relating to certain liquidating subsidiary corporations) applies, a

April 6, 1998

qualifying installment obligation acquired

in respect of a sale or exchange by the liquidating subsidiary corporation will be

treated as a qualifying installment obligation if distributed by a controlling corporate shareholder (within the meaning of

section 368(c)) to a qualifying shareholder. The preceding sentence is applied

successively to each controlling corporate

shareholder, if any, above the first controlling corporate shareholder.

(ii) Examples. The provisions of this

paragraph (c)(3) are illustrated by the following examples:

Example 1. (i) A, an individual, owns all of the

stock of T corporation, a C corporation. T has an

operating division and three wholly-owned subsidiaries, X, Y, and Z. On February 1, 1998, T, Y,

and Z all adopt plans of complete liquidation.

(ii) On March 1, 1998, the following sales are

made to unrelated purchasers: T sells the assets of

its operating division to B for cash and an installment obligation. T sells the stock of X to C for an

installment obligation. Y sells all of its assets to D

for an installment obligation. Z sells all of its assets

to E for cash. The B, C, and D installment obligations bear adequate stated interest and meet the requirements of section 453.

(iii) In June 1998, Y and Z completely liquidate,

distributing their respective assets (the D installment

obligation and cash) to T. In July 1998, T completely

liquidates, distributing to A cash and the installment

obligations respectively issued by B, C, and D. The

liquidation of T is a liquidation to which section

453(h) applies and the liquidations of Y and Z into T

are liquidations to which section 332 applies.

(iv) Because T is in control of Y (within the

meaning of section 368(c)), the D obligation acquired by Y is treated as acquired by T pursuant to

section 453(h)(1)(E). A is a qualifying shareholder

and the installment obligations issued by B, C, and

D are qualifying installment obligations. Unless A

elects otherwise, A reports the transaction on the installment method as if the cash and installment

obligations had been received in an installment sale

of the stock of T corporation. Under section

453B(d), no gain or loss is recognized by Y on the

distribution of the D installment obligation to T.

Under sections 453B(a) and 336, T recognizes gain

or loss on the distribution of the B, C, and D installment obligations to A in exchange for A’s stock.

Example 2. (i) A, a cash-method individual taxpayer, owns all of the stock of P corporation, a C

corporation. P owns 30 percent of the stock of Q

corporation. The balance of the Q stock is owned by

unrelated individuals. On February 1, 1998, P

adopts a plan of complete liquidation and sells all of

its property, other than its Q stock, to B, an unrelated

purchaser for cash and an installment obligation

bearing adequate stated interest. On March 1, 1998,

Q adopts a plan of complete liquidation and sells all

of its property to an unrelated purchaser, C, for cash

and installment obligations. Q immediately distributes the cash and installment obligations to its shareholders in completion of its liquidation. Promptly

April 6, 1998

thereafter, P liquidates, distributing to A cash, the B

installment obligation, and a C installment obligation that P received in the liquidation of Q.

(ii) In the hands of A, the B installment obligation is a qualifying installment obligation. In the

hands of P, the C installment obligation was a qualifying installment obligation. However, in the hands

of A, the C installment obligation is not treated as a

qualifying installment obligation because P owned

only 30 percent of the stock of Q. Because P did not

own the requisite 80 percent stock interest in Q, P

was not a controlling corporate shareholder of Q

(within the meaning of section 368(c)) immediately

before the liquidation. Therefore, section 453(h)(1)(E) does not apply. Thus, in the hands of A, the C

obligation is considered to be a third-party note (not

a purchaser’s evidence of indebtedness) and is

treated as a payment to A in the year of distribution.

Accordingly, for 1998, A reports as payment the

cash and the fair market value of the C obligation

distributed to A in the liquidation of P.

(iii) Because P held 30 percent of the stock of Q,

section 453B(d) is inapplicable to P. Under sections

453B(a) and 336, accordingly, Q recognizes gain or

loss on the distribution of the C obligation. P also

recognizes gain or loss on the distribution of the B

and C installment obligations to A in exchange for

A’s stock. See sections 453B and 336.

(4) Installment obligations attributable

to certain sales of inventory—(i) In general. An installment obligation acquired

by a corporation in a liquidation that satisfies section 453(h)(1)(A) in respect of a

broken lot of inventory is not a qualifying

installment obligation. If an installment

obligation is acquired in respect of a broken lot of inventory and other assets, only

the portion of the installment obligation

acquired in respect of the broken lot of inventory is not a qualifying installment

obligation. The portion of the installment

obligation attributable to other assets is a

qualifying installment obligation. For

purposes of this section, the term broken

lot of inventory means inventory property

that is sold or exchanged other than in

bulk to one person in one transaction involving substantially all of the inventory

property attributable to a trade or business

of the corporation. See paragraph (c)(4)(ii) of this section for rules for determining what portion of an installment obligation is not a qualifying installment

obligation and paragraph (c)(4)(iii) of this

section for rules determining the application of payments on an installment obligation only a portion of which is a qualifying installment obligation.

(ii) Rules for determining nonqualifying portion of an installment obligation.

If a broken lot of inventory is sold to a

purchaser together with other corporate

assets for consideration consisting of an

installment obligation and either cash,

other property, the assumption of (or taking property subject to) corporate liabilities by the purchaser, or some combination thereof, the installment obligation is

treated as having been acquired in respect

of a broken lot of inventory only to the

extent that the fair market value of the

broken lot of inventory exceeds the sum

of unsecured liabilities assumed by the

purchaser, secured liabilities which encumber the broken lot of inventory and

are assumed by the purchaser or to which

the broken lot of inventory is subject, and

the sum of the cash and fair market value

of other property received. This rule applies solely for the purpose of determining the portion of the installment obligation (if any) that is attributable to the

broken lot of inventory.

(iii) Application of payments. If, by

reason of the application of paragraph

(c)(4)(ii) of this section, a portion of an

installment obligation is not a qualifying

installment obligation, then for purposes

of determining the amount of gain to be

reported by the shareholder under section

453, payments on the obligation (other

than payments of qualified stated interest)

shall be applied first to the portion of the

obligation that is not a qualifying installment obligation.

(iv) Example. The following example

illustrates the provisions of this paragraph

(c)(4). In this example, assume that all

obligations bear adequate stated interest

within the meaning of section 1274(c)(2)

and that the fair market value of each nonqualifying installment obligation equals

its face amount.

The example is as follows:

Example. (i) P corporation has three operating

divisions, X, Y, and Z, each engaged in a separate

trade or business, and a minor amount of investment

assets. On July 1, 1998, P adopts a plan of complete

liquidation that meets the criteria of section

453(h)(1)(A). The following sales are promptly

made to purchasers unrelated to P: P sells all of the

assets of the X division (including all of the inventory property) to B for $30,000 cash and installment

obligations totalling $200,000. P sells substantially

all of the inventory property of the Y division to C

for a $100,000 installment obligation, and sells all of

the other assets of the Y division (excluding cash but

including installment receivables previously acquired in the ordinary course of the business of the Y

division) to D for a $170,000 installment obligation.

P sells 1/3 of the inventory property of the Z division

1998–14 I.R.B.

to E for $100,000 cash, 1/3 of the inventory property

of the Z division to F for a $100,000 installment

obligation, and all of the other assets of the Z division (including the remaining 1/3 of the inventory

property worth $100,000) to G for $60,000 cash, a

$240,000 installment obligation, and the assumption

by G of the liabilities of the Z division. The liabilities assumed by G, which are unsecured liabilities

and liabilities encumbering the inventory property

acquired by G, aggregate $30,000. Thus, the total

purchase price G pays is $330,000.

(ii) P immediately completes its liquidation, distributing the cash and installment obligations, which

otherwise meet the requirements of section 453, to

A, an individual cash-method taxpayer who is its

sole shareholder. In 1999, G makes a payment to A

of $100,000 (exclusive of interest) on the $240,000

installment obligation.

(iii) In the hands of A, the installment obligations

issued by B, C, and D are qualifying installment

obligations because they were timely acquired by P

in a sale or exchange of its assets. In addition, the

installment obligation issued by C is a qualifying installment obligation because it arose from a sale to

one person in one transaction of substantially all of

the inventory property of the trade or business engaged in by the Y division.

(iv) The installment obligation issued by F is not

a qualifying installment obligation because it is in

respect of a broken lot of inventory. A portion of the

installment obligation issued by G is a qualifying installment obligation and a portion is not a qualifying

installment obligation, determined as follows: G

purchased part of the inventory property (with a fair

market value of $100,000) and all of the other assets

of the Z division by paying cash ($60,000), issuing

an installment obligation ($240,000), and assuming

liabilities of the Z division ($30,000). The assumed

liabilities ($30,000) and cash ($60,000) are attributed first to the inventory property. Therefore, only

$10,000 of the $240,000 installment obligation is attributed to inventory property. Accordingly, in the

hands of A, the G installment obligation is a qualifying installment obligation to the extent of $230,000,

but is not a qualifying installment obligation to the

extent of the $10,000 attributable to the inventory

property.

(v) In the 1998 liquidation of P, A receives a liquidating distribution as follows:

Item

cash

B note

C note

D note

F note

G note1

Total

Qualifying InstallCash and

ment Obligations Other Property

$190,000

$200,000

$100,000

$170,000

$230,000

$700,000

$100,000

$ 10,000

$300,000

(vi) Assume that A’s adjusted tax basis in the

stock of P is $100,000. Under the installment

method, A’s selling price and the contract price are

both $1 million, the gross profit is $900,000 (selling

price of $1 million less adjusted tax basis of

$100,000), and the gross profit ratio is 90 percent

(gross profit of $900,000 divided by the contract

1Face amount $240,000.

1998–14 I.R.B.

price of $1 million). Accordingly, in 1998, A reports

gain of $270,000 (90 percent of $300,000 payment

in cash and other property). A’s adjusted tax basis in

each of the qualifying installment obligations is an

amount equal to 10 percent of the obligation’s respective face amount. A’s adjusted tax basis in the F

note, a nonqualifying installment obligation, is

$100,000, i.e., the fair market value of the note when

received by A. A’s adjusted tax basis in the G note, a

mixed obligation, is $33,000 (10 percent of the

$230,000 qualifying installment obligation portion

of the note, plus the $10,000 nonqualifying portion

of the note).

(vii) With respect to the $100,000 payment received from G in 1999, $10,000 is treated as the recovery of the adjusted tax basis of the nonqualifying

portion of the G installment obligation and $9,000

(10 percent of $90,000) is treated as the recovery of

the adjusted tax basis of the portion of the note that

is a qualifying installment obligation. The remaining $81,000 (90 percent of $90,000) is reported as

gain from the sale of A’s stock. See paragraph

(c)(4)(iii) of this section.

(5) Installment obligations attributable

to sales of certain property—(i) In general. An installment obligation acquired

by a liquidating corporation, to the extent

attributable to the sale of property described in paragraph (c)(5)(ii) of this section, is not a qualifying obligation if the

corporation is formed or availed of for a

principal purpose of avoiding section

453(b)(2) (relating to dealer dispositions

and certain other dispositions of personal

property), section 453(i) (relating to sales

of property subject to recapture), or section 453(k) (relating to dispositions under

a revolving credit plan and sales of stock

or securities traded on an established securities market) through the use of a party

bearing a relationship, either directly or

indirectly, described in section 267(b) to

any shareholder of the corporation.

(ii) Covered property. Property is described in this paragraph (c)(5)(ii) if,

within 12 months before or after the adoption of the plan of liquidation, the property was owned by any shareholder and—

(A) The shareholder regularly sold or

otherwise disposed of personal property

of the same type on the installment plan

or the property is real property that the

shareholder held for sale to customers in

the ordinary course of a trade or business

(provided the property is not described in

section 453(l)(2) (relating to certain exceptions to the definition of dealer dispositions));

(B) The sale of the property by the

shareholder would result in recapture in-

come (within the meaning of section

453(i)(2)), but only if the amount of the

recapture income is equal to or greater

than 50 percent of the property’s fair market value on the date of the sale by the

corporation;

that are traded on an established securities

market; or

(D) The sale of the property by the

shareholder would have been under a revolving credit plan.

(iii) Safe harbor. Paragraph (c)(5)(i)

of this section will not apply to the liquidation of a corporation if, on the date the

plan of complete liquidation is adopted

and thereafter, less than 15 percent of the

fair market value of the corporation’s assets is attributable to property described

in paragraph (c)(5)(ii) of this section.

(iv) Example. The provisions of this

paragraph (c)(5) are illustrated by the following example:

Example. Ten percent of the fair market value of

the assets of T is attributable to stock and securities

traded on an established securities market. T owns

no other assets described in paragraph (c)(5)(ii) of

this section. T, after adopting a plan of complete liquidation, sells all of its stock and securities holdings

to C corporation in exchange for an installment

obligation bearing adequate stated interest, sells all

of its other assets to B corporation for cash, and distributes the cash and installment obligation to its sole

shareholder, A, in a complete liquidation that satisfies section 453(h)(1)(A). Because the C installment

obligation arose from a sale of publicly traded stock

and securities, T cannot report the gain on the sale

under the installment method pursuant to section

453(k)(2). In the hands of A, however, the C installment obligation is treated as having arisen out of a

sale of the stock of T corporation. In addition, the

general rule of paragraph (c)(5)(i) of this section

does not apply, even if a principal purpose of the liquidation was the avoidance of section 453(k)(2), because the fair market value of the publicly traded

stock and securities is less than 15 percent of the total

fair market value of T’s assets. Accordingly, section

453(k)(2) does not apply to A, and A may use the installment method to report the gain recognized on the

payments it receives in respect of the obligation.

(d) Liquidating distributions received

in more than one taxable year. If a qualifying shareholder receives liquidating distributions to which this section applies in

more than one taxable year, the shareholder must reasonably estimate the gain

attributable to distributions received in

each taxable year. In allocating basis to

calculate the gain for a taxable year, the

shareholder must reasonably estimate the

anticipated aggregate distributions. For

April 6, 1998

this purpose, the shareholder must take

into account distributions and other relevant events or information that the shareholder knows or reasonably could know

up to the date on which the federal income

tax return for that year is filed. If the gain

for a taxable year is properly taken into account on the basis of a reasonable estimate

and the exact amount is subsequently determined the difference, if any, must be

taken into account for the taxable year in

which the subsequent determination is

made. However, the shareholder may file

an amended return for the earlier year in

lieu of taking the difference into account

for the subsequent taxable year.

Section 468.—Special Rules for

Mining and Solid Waste

Reclamation and Closing Costs

(e) Effective date. This section is applicable to distributions of qualifying installment obligations made on or after

January 28, 1998.

Section 483.—Interest on

Certain Deferred Payments

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

Approved December 18, 1997.

Donald C. Lubick,

Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

January 27, 1998, 8:45 a.m., and published in the

issue of the Federal Register for January 28, 1998,

63 F.R. 4168)

Section 467.—Certain Payments

for the Use of Property or

Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

April 6, 1998

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

Section 482.—Allocation of

Income and Deductions Among

Taxpayers

Federal short-term, mid-term, and long-term

rates are set forth for the month of April 1998. See

Rev. Rul. 98–18, page 22.

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

Section 642.—Special Rules for

Credits and Deductions

Federal short-term, mid-term, and long-term

rates are set forth for the month of April 1998. See

Rev. Rul. 98–18, page 22.

Section 807.—Rules for Certain

Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

Section 846.—Discounted

Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

Section 1274.—Determination

of Issue Price in the Case of

Certain Debt Instruments Issued

for Property

(Also Sections 42, 280G, 382, 412, 467, 468, 482,

483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates;

adjusted federal long-term rate, and

the long-term exempt rate. For purposes

of sections 1274, 1288, 382, and other

sections of the Code, tables set forth the

rates for April 1998.

Rev. Rul. 98–18

This revenue ruling provides various

prescribed rates for federal income tax

purposes for April 1998 (the current

month.) Table 1 contains the short-term,

mid-term, and long-term applicable federal rates (AFR) for the current month

for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains

the short-term, mid-term, and long-term

adjusted applicable federal rates (adjusted AFR) for the current month for

purposes of section 1288(b). Table 3

sets forth the adjusted federal long-term

rate and the long-term tax-exempt rate

described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit

described in section 42(b)(2) for buildings placed in service during the current

month. Finally, Table 5 contains the federal rate for determining the present

value of an annuity, an interest for life or

for a term of years, or a remainder or a

reversionary interest for purposes of section 7520.

1998–14 I.R.B.

REV. RUL. 98–18 TABLE 1

Applicable Federal Rates (AFR) for April 1998

Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-Term

AFR

110% AFR

120% AFR

130% AFR

5.51%

6.07%

6.64%

7.19%

5.44%

5.98%

6.53%

7.07%

5.40%

5.94%

6.48%

7.01%

5.38%

5.91%

6.44%

6.97%

Mid-Term

AFR

110% AFR

120% AFR

130% AFR

150% AFR

175% AFR

5.70%

6.28%

6.85%

7.44%

8.61%

10.08%

5.62%

6.18%

6.74%

7.31%

8.43%

9.84%

5.58%

6.13%

6.68%

7.24%

8.34%

9.72%

5.56%

6.10%

6.65%

7.20%

8.29%

9.64%

Long-Term

AFR

110% AFR

120% AFR

130% AFR

5.98%

6.58%

7.19%

7.81%

5.89%

6.48%

7.07%

7.66%

5.85%

6.43%

7.01%

7.59%

5.82%

6.39%

6.97%

7.54%

REV. RUL. 98–18 TABLE 2

Adjusted AFR for April 1998

Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-term

adjusted AFR

3.67%

3.64%

3.62%

3.61%

Mid-term

adjusted AFR

4.24%

4.20%

4.18%

4.16%

Long-term

adjusted AFR

5.04%

4.98%

4.95%

4.93%

REV. RUL. 98–18 TABLE 3

Rates Under Section 382 for April 1998

Adjusted federal long-term rate for the current month

5.04%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the

adjusted federal long-term rates for the current month and the prior two months.)

5.04%

1998–14 I.R.B.

April 6, 1998

REV. RUL. 98–18 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for April 1998

Appropriate percentage for the 70% present value low-income housing credit

8.37%

Appropriate percentage for the 30% present value low-income housing credit

3.59%

REV. RUL. 98–18 TABLE 5

Rate Under Section 7520 for April 1998

Applicable federal rate for determining the present value of an annuity, an interest for life or a

term of years, or a remainder or reversionary interest

Section 1288.—Treatment of

Original Issue Discount on TaxExempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

April 6, 1998

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

6.8%

Section 7872.—Treatment of

Loans with Below-Market

Interest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month

of April 1998. See Rev. Rul. 98–18, page 22.

1998–14 I.R.B.

Part IV. Items of General Interest

Notice of Proposed Rulemaking

and Notice of Public Hearing

LaNita Van Dyke, (202) 622-7190 (not

toll-free numbers).

Continuity of Interest

SUPPLEMENTARY INFORMATION:

REG–120882–97

Background

AGENCY: Internal Revenue Service

(IRS), Treasury.

In T.D. 8761, temporary regulations

amend the Income Tax Regulations (26

CFR part 1) under section 368. The temporary regulations provide that in determining whether the continuity of interest

requirement for corporate reorganizations

is satisfied with respect to a potential reorganization, a proprietary interest in the target corporation is not preserved if, in connection with a potential reorganization, it

is redeemed or acquired by a person related to the target corporation, or to the extent that, prior to and in connection with a

potential reorganization, an extraordinary

distribution is made with respect to it.

The text of the temporary regulations

also serves as the text of these proposed

regulations. The preamble to the temporary regulations describes the temporary

regulations.

The temporary regulations do not provide guidance on the determination of

whether a distribution will be treated as

an extraordinary distribution, except that

the rules of section 1059 do not apply for

this purpose. The IRS and Treasury Department invite comments on whether the

regulations should provide more specific

guidance in this area.

ACTION: Notice of proposed rulemaking by cross-reference to temporary regulations and notice of public hearing.

SUMMARY: In T.D. 8761, page 13 of

this Bulletin, the IRS is issuing temporary

regulations providing guidance regarding

satisfaction of the continuity of interest

requirement for corporate reorganizations. The temporary regulations affect

corporations and their shareholders. The

text of those temporary regulations also

serves as the text of these proposed regulations. In addition, this document provides notice of a public hearing on these

proposed regulations.

DATES: Written comments and outlines

of topics to be discussed at the hearing

scheduled for Tuesday, May 26, 1998,

must be received by Tuesday, May 5,

1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–120882–97),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to CC:DOM:CORP:R

(REG–120882–97), Courier’s Desk, Internal Revenue Service, 1111 Constitution

Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting

the “Tax Regs” option on the IRS Home

Page, or by submitting comments directly

to the IRS Internet site at http://www.irs.

ustreas.gov/prod/tax_regs/comments.html.

The public hearing will be held in room

2615, Internal Revenue Building, 1111

Constitution Avenue NW, Washington,

DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,

Phoebe Bennett, (202) 622-7750; concerning submissions and the hearing,

1998–14 I.R.B.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and because the regulation does not

impose a collection of information on

small entities, the Regulatory Flexibility

Act (5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the Internal

Revenue Code, this notice of proposed

rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment on its

impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any comments that

are submitted timely to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled at

10 a.m. on Tuesday, May 26, 1998, in

room 2615, Internal Revenue Service,

1111 Constitution Avenue NW, Washington, DC. Because of access restrictions,

visitors will not be admitted beyond the

Internal Revenue Building lobby more

than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral comments at the hearing must submit written

comments by Tuesday, May 5, 1998 and

submit an outline of the topics to be discussed and the time to be devoted to each

topic (a signed original and eight (8)

copies) by Tuesday, May 5, 1998.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Proposed Effective Date

These regulations are proposed to

apply to transactions occurring after January 28, 1998, except that they do not

apply to any transaction occurring pursuant to a written agreement which is

(subject to customary conditions) binding

on January 28, 1998, and at all times

thereafter.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.368–1 is amended as

follows:

April 6, 1998

1. Revising paragraphs (e)(1)(ii)(A),

(e)(1)(ii)(B), (e)(2)(ii), and (f).

2. Adding paragraph (e)(6) Example

10 and Example 11.

The addition and revisions read as follows:

§1.368-– Purpose and scope of exception

of reorganization exchanges.

[The text of proposed paragraphs

(e)(1)(ii)(A) and (B), (e)(2)(ii), (e)(6) Example 10 and Example 11, and (f) is the

same as the text of §1.368–1T published

in T.D. 8761.]

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on

January 23, 1998, 12:15 p.m., and published in the

issue of the Federal Register for January 28, 1998,

63 F.R. 4204)

Notice of Proposed Rulemaking

and Notice of Public Hearing

Election to Amortize Start-Up

Expenditures

REG–209373–81

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains

proposed regulations concerning start-up

expenditures under section 195. The proposed regulations provide rules and procedures for electing to amortize start-up

expenditures under section 195. The regulations affect all taxpayers wishing to

amortize start-up expenditures under section 195. This document also provides

notice of a public hearing on these proposed regulations.

DATES: Comments and outlines of topics to be discussed at the public hearing

scheduled for June 2, 1998, at 10 a.m.,

must be received by April 13, 1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (PS–36–81), room

5228, Internal Revenue Service, POB

7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, submis-

April 6, 1998

sions may be hand-delivered between the

hours of 8:15 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–209373–81),

Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW,

Washington, DC, or electronically, via the

IRS Internet site at: http://www.irs.ustreas.gov/prod/tax_regs/comments.html.

The public hearing will be held in the

NYU Classroom, Room 2615, Internal

Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,

David Selig, (202) 622-3040; concerning

submissions and the hearing, LaNita

VanDyke, (202) 622-7180 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of

Management and Budget for review in

accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)).

Comments on the collection of information should be sent to the Office of

Management and Budget, Attn: Desk

Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with

copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer,

T:FP, Washington, DC 20224. Comments

on the collection of information should be

received by March 16, 1998.

Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal

Revenue Service, including whether the

information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of

information (see below);

How the quality, utility, and clarity of the

information to be collected may be enhanced;

How the burden of complying with the

proposed collection of information may

be minimized, including through the application of automated collection techniques or other forms of information tech-

nology; and

Estimates of capital or start-up costs of

operation, maintenance, and purchase of

services to provide information.

The requirement for the collection of

information in this notice of proposed

rulemaking is in §1.195-1(c). This information is required by the IRS to establish

that a taxpayer properly has made an election to amortize start-up expenditures

under section 195. This information will

be used to determine whether the amount

amortized under section 195 has been

computed properly. The likely respondents are businesses and other for-profit

organizations. Responses to this collection of information are required to make

an election to amortize start-up expenditures under section 195.

Estimated total annual reporting burden:

37,500 hours.

The estimated annual burden per respondent varies from .10 hours to .50 hour, depending on individual circumstances,

with an estimated average of .25 hours.

Estimated number of respondents :

150,000.

Estimated annual frequency of responses:

one-time election.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the collection of information displays a valid

OMB control number.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

This document contains proposed

amendments to the Income Tax Regulations (26 CFR part 1) to provide regulations under section 195 of the Internal

Revenue Code. Section 195 was added to

the Internal Revenue Code of 1954 by

section 102 of the Miscellaneous Revenue

Act of 1980, and amended by section 94

of the Tax Reform Act of 1984.

Section 195 generally provides that no

deduction is allowed for start-up expenditures unless the taxpayer elects to amortize the expenditures. If the taxpayer

elects to amortize start-up expenditures

under section 195(b)(1), the expenditures

1998–14 I.R.B.

are amortizable over a period of not less

than 60 months beginning with the month

when the active trade or business begins.

Under section 195(d), an election to

amortize start-up expenditures must be

made not later than the time prescribed by

law for filing the return for the taxable

year in which the active trade or business

begins (including extensions thereof).

Announcement 81–43 (1981–1 I.R.B. 52)

described the time and manner for making

this election.

An expense is a start-up expenditure if

it satisfies two conditions. First, the expense must be paid or incurred in connection with any one of the following: (1)

creating an active trade or business, (2)

investigating the creation or acquisition of

an active trade or business, or (3) any activity entered into for profit and for the

production of income before the day on

which the active trade or business begins,

in anticipation of the activity becoming an

active trade or business (expenditures in

this last category are start-up expenditures

only if they are attributable to periods

after June 30, 1984).

Second, the expenditure must be of the

type that, if paid or incurred in connection

with the operation of an existing active

trade or business in the same field as that

being entered into by the taxpayer, would

be allowable as a deduction for the taxable year when paid or incurred.

Explanation of Provisions

The proposed regulations provide that

an election to amortize start-up expenditures is made by attaching a statement to

the taxpayer’s income tax return. The income tax return and statement must be

filed not later than the date prescribed by

law for filing the income tax return (including any extensions of time) for the

taxable year when the active trade or business begins.

The IRS is interested in ways to simplify the filing of elections. The proposed

regulations are intended to simplify the

filing of section 195 elections in two

ways. First, the proposed regulations

clarify that a taxpayer who is uncertain as

to the year in which the active trade or

business begins need not file an election

for each possible taxable year. Rather, a

section 195 election for a particular trade

or business will be effective if the trade or

business becomes active in the year for

1998–14 I.R.B.

which the election is filed or in any subsequent year. In developing this notice of

proposed rulemaking, more burdensome

methods of making the election were considered and rejected. For example, an approach that would have required taxpayers to file an election statement each year

was rejected. Second, the proposed regulations also allow taxpayers who have

made timely elections under section 195

to file a revised statement with a subsequent return to include any start-up expenditures not included in the original

statement.

Persons that wish to present oral comments at the hearing must submit comments by April 13, 1998 and submit an

outline of the topics to be discussed and

the time to be devoted to each topic by

April 13, 1998.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It is hereby certified

that these regulations do not have a significant impact on a substantial number of

small entities. This certification is based

upon the fact that the time required to prepare and file the election statement is

minimal and will not have a significant

impact on those small entities that choose

to make the election. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter

6) is not required. Pursuant to section

7805(f) of the Internal Revenue Code,

this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small

business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any comments that

are submitted (in the manner described in

the ADDRESSES caption) timely to the

IRS. All comments will be available for

public inspection and copying.

A public hearing has been scheduled

for Tuesday, June 2, 1998, at 10 a.m. in

the NYU Classroom, Room 2615, Internal Revenue Building, 1111 Constitution

Avenue, NW, Washington DC. Because

of access restrictions, visitors will not be

admitted beyond the Internal Revenue

Building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

The principal author of these regulations is David Selig, Office of the Assistant Chief Counsel (Passthroughs and

Special Industries), IRS. However, other

personnel from the IRS and Treasury Department participated in their development.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.195–1 is added to

read as follows:

§1.195–1 Election to amortize start-up

expenditures.

(a) In general. Under sectio

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