Limitations on Corporate Net Operating Loss

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8546]

RIN 1545-AL58

Limitations on Corporate Net Operating Loss

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final income tax regulations providing

rules for allocating net operating loss or taxable income, and net

capital loss or gain, within the taxable year in which a loss

corporation has an ownership change under section 382 of the Internal

Revenue Code of 1986. These regulations permit the loss corporation to

elect to allocate these amounts between the period ending on the change

date and the period beginning on the day after the change date as if

its books were closed on the change date.

EFFECTIVE DATE: These regulations are effective June 22, 1994.

For dates of applicability of these regulations, see the EFFECTIVE

DATE paragraph in the SUPPLEMENTARY INFORMATION portion of the

preamble.

FOR FURTHER INFORMATION CONTACT: Roberta F. Mann of the Office of

Assistant Chief Counsel (Corporate), Office of Chief Counsel, IRS, 1111

Constitution Avenue, NW, Washington, DC 20224 (Attention:

CC:DOM:CORP:5) or telephone 202-622-7550 (not a toll- free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations

has been reviewed and approved by the Office of Management and Budget

in accordance with the Paperwork Reduction Act (44 U.S.C. 3504(h))

under control number 1545-1381. The estimated annual burden per

respondent is estimated to be 0.1 hour.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be directed to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP,

Washington, DC 20224, and to the Office of Management and Budget,

Attention: Desk Officer for the Department of the Treasury, Office of

Information and Regulatory Affairs, Washington, DC 20503.

Background

This document contains final regulations to be added to the Income

Tax Regulations (26 CFR part 1) under section 382 of the Internal

Revenue Code. The final regulations provide rules for the allocation of

net operating loss or taxable income and net capital loss or gain

within the taxable year in which a loss corporation has an ownership

change. Proposed regulations on this subject were set forth in a notice

of proposed rulemaking published in the Federal Register on November

19, 1992 (57 FR 54535). The IRS received public comments on the

proposed regulations. No public hearing was requested and none was

held. Having considered the comments submitted, the IRS and the

Treasury Department adopt the proposed regulations as revised by this

Treasury decision.

Explanation of Provisions

Following an ownership change, section 382 limits the amount of

post-change income that may be offset by a corporation's pre-change

loss. Sections 382(b)(3)(A) and (d)(1) require that, except as provided

in section 382(h)(5) (relating to certain built-in gains and losses)

and in regulations, taxable income or net operating loss must be

allocated ratably to each day in the change year for purposes of

applying the section 382 limitation. Under section 383, similar rules

apply with respect to pre-change capital losses and certain pre-change

credits.

The proposed regulations provide rules for allocation of net

operating loss or taxable income, and net capital loss or gain, within

the change year. The proposed regulations generally provide that a loss

corporation may allocate such items between the pre-change period and

the post-change period (1) by ratably allocating an equal portion to

each day in the change year, or (2) if it so elects, based on a closing

of its books as of the change date. The final regulations adopt the

proposed regulations with few changes. The most significant comments

and changes are described below.

A. Consistency Rules for Consolidated and Controlled Groups

The proposed regulations provide consistency rules for corporations

that are members of consolidated groups or controlled groups. These

consistency rules are based on proposed regulations applying section

382 to consolidated and controlled groups. The consistency rules

contained in the proposed regulations have been revised in the final

regulations because the proposed consolidated and controlled group

regulations have not been finalized yet. The final regulations provide

that if a closing-of-the-books election is made with respect to an

ownership change occurring during a consolidated return year, all

allocations with respect to that ownership change must be consistent

with the election. Further consideration will be given to consistency

rules for consolidated groups in the development of final regulations

applying section 382 to these groups. -

B. Limitation Increase Rule

In Notice 87-79, 1987-2 C.B. 387, the IRS announced its intention

to issue regulations that would allow taxpayers to make a closing-of-

the-books election. The Notice stated that, prior to the issuance of

regulations, taxpayers would be required to use the statutory ratable

allocation method unless they obtained a private letter ruling allowing

them to use a different method.

Pursuant to Notice 87-79, the IRS issued a number of private letter

rulings that authorized allocations based on a closing of the

taxpayers' books. Some of these rulings allowed taxpayers to increase

in their section 382 limitation to the extent that any net pre-change

income was offset by net post-change loss in computing taxable income

or loss for the change year. The purpose of the increased limitation

was to put the taxpayer in a position similar to the position it would

have been in had its taxable year ended on the change date.

In the interest of simplicity, the proposed regulations do not

include a rule providing for increases in the annual section 382

limitation in cases in which net post-change loss offsets net pre-

change income. Several commentators questioned the failure to include a

limitation increase rule.

The final regulations retain the approach of the proposed

regulations, in which change year income and losses may be netted

together without limitation. This approach may be either favorable or

unfavorable to taxpayers, depending on the circumstances. This approach

is disadvantageous when it results in the netting of a post-change loss

against pre-change income. Conversely, the approach is advantageous to

taxpayers that are able to net a pre-change loss against post-change

income without limitation. In these cases, if the taxpayers' year had

ended on the change date, the loss so used would have been subject to

the section 382 limitation.

Adoption of a limitation increase rule would add significant

complexity to the regulations. If taxpayers were protected from the

disadvantages of netting a post-change loss against pre- change income,

consistency would require that taxpayers not be allowed the benefit of

netting pre-change loss against post- change income without limitation.

In other words, detailed rules for applying the section 382 limitation

within the change year to limit the use of a loss in the pre-change

portion of the year against income in the post-change period would be

necessary concomitants of a limitation increase rule. To avoid this

complexity, the final regulations allow change year losses to offset

change year income without limitation and do not include a limitation

increase rule.

C. Additional Issues

The preamble to the proposed regulations requested comments on the

interaction of the ratable allocation rules under the proposed

regulations and the built-in gain and loss rules under section 382(h),

particularly with respect to extraordinary items (e.g., an asset sale

not made in the ordinary course of business). A commentator recommended

that the final regulations include both a rule for extraordinary items

and the limitation increase rule (described in paragraph B above).

After due consideration, the IRS and the Treasury Department decided

that rules relating to extraordinary items would add unnecessary

complexity to the final regulations. Thus, the final regulations do not

contain special rules with respect to the allocation of extraordinary

items. The IRS and the Treasury Department may give further

consideration to the desirability of rules addressing extraordinary

items.

D. Effective Date

The regulations apply to ownership changes occurring on or after

June 22, 1994.

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 has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations, and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information

The principal author of these regulations is Roberta F. Mann,

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

personnel from the IRS and Treasury Department participated in their

development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

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 * * * Sec. 1.382-6 also issued under

26 U.S.C. 382(b)(3)(A), 26 U.S.C. 382(d)(1), 26 U.S.C. 382(m), and

26 U.S.C. 383(d) * * *

Par 2. Section 1.382-1 is amended by revising the entry for

Sec. 1.382-6 and adding additional entries to read as follows:

Sec. 1.382-1 Table of contents.

* * * * *

Sec. 1.382-6 Allocation of income and loss to periods before and

after the change date for purposes of section 382.

(a) General rule.

(b) Closing-of-the-books election.

(1) In general.

(2) Making the closing-of-the-books election.

(i) Time and manner.

(ii) Election irrevocable.

(3) Special rules relating to consolidated and controlled

groups.

(i) Consolidated groups.

(ii) Controlled groups.

(c) Operating rules for determining net operating loss, taxable

income, net capital loss, modified capital gain net income, and

special allocations.

(1) In general.

(2) Adjustment to net operating loss.

(i) Determination of remaining capital gain.

(ii) Reduction of net operating loss by remaining capital gain.

(d) Coordination with rules relating to the allocation of income

under Sec. 1.1502-76(b).

(e) Allocation of certain credits.

(f) Examples.

(g) Definitions and nomenclature.

(1) Change year.

(2) Pre-change period.

(3) Post-change period.

(4) Modified capital gain net income.

(h) Effective date.

* * * * *

Par. 3. The heading of Sec. 1.382-6 is revised, and the text of the

section is added to read as follows:

Sec. 1.382-6 Allocation of income and loss to periods before and after

the change date for purposes of section 382.

(a) General rule. Except as provided in paragraphs (b) and (d) of

this section, a loss corporation must allocate its net operating loss

or taxable income (see section 382(k)(4)), and its net capital loss

(see section 1222(10)) or modified capital gain net income (as defined

in paragraph (g)(4) of this section), for the change year between the

pre-change period and the post-change period by ratably allocating an

equal portion to each day in the year.

(b) Closing-of-the-books election--(1) In general. Subject to

paragraphs (b)(3)(ii) and (d) of this section, a loss corporation may

elect to allocate its net operating loss or taxable income and its net

capital loss or modified capital gain net income for the change year

between the pre-change period and the post-change period as if the loss

corporation's books were closed on the change date. An election under

this paragraph (b)(1) does not terminate the loss corporation's taxable

year as of the change date (e.g., the change year is a single tax year

for purposes of section 172).

(2) Making the closing-of-the-books election--(i) Time and manner.

A loss corporation makes the closing-of-the-books election by including

the following statement on the information statement required by

Sec. 1.382-2T(a)(2)(ii) for the change year: ``THE CLOSING-OF-THE-BOOKS

ELECTION UNDER Sec. 1.382-6(b) IS HEREBY MADE WITH RESPECT TO THE

OWNERSHIP CHANGE OCCURRING ON [INSERT DATE].'' The election must be

made on or before the due date (including extensions) of the loss

corporation's income tax return for the change year.

(ii) Election irrevocable. An election under this paragraph (b) is

irrevocable.

(3) Special rules relating to consolidated and controlled groups--

(i) Consolidated groups. If an election under this paragraph (b) is

made with respect to an ownership change occurring in a consolidated

return year, all allocations under this section with respect to that

ownership change must be consistent with the election.

(ii) Controlled groups. If paragraph (b)(3)(i) of this section does

not apply, and if, as part of the same plan or arrangement, two or more

members of a controlled group (as defined in section 1563(a),

determined by substituting ``50 percent'' for ``80 percent'' each place

that it appears, and without regard to section 1563(a)(4)), have

ownership changes and continue to be members of the controlled group

(or become members of the same other controlled group), a closing-of-

the-books election applies only if the election is made by all members

having the ownership changes.

(c) Operating rules for determining net operating loss, taxable

income, net capital loss, modified capital gain net income, and special

allocations. For purposes of this section, for the change year--

(1) In general--(i) Net operating loss or taxable income is

determined without regard to gains or losses on the sale or exchange of

capital assets; and

(ii) Net operating loss or taxable income and net capital loss or

modified capital gain net income are determined without regard to the

section 382 limitation and do not include the following items, which

are allocated entirely to the post-change period--

(A) Any income, gain, loss, or deduction to which section

382(h)(5)(A) applies; and

(B) Any income or gain recognized on the disposition of assets

transferred to the loss corporation during the post-change period for a

principal purpose of ameliorating the section 382 limitation.

(2) Adjustment to net operating loss--(i) Determination of

remaining capital gain. The amount of modified capital gain net income

(defined in paragraph (g)(4) of this section) allocated to each period

is offset by capital losses to which section 382(h)(5)(A) applies and

capital loss carryovers, subject to the section 382 limitation (in the

case of modified capital gain net income allocated to the post-change

period).

(ii) Reduction of net operating loss by remaining capital gain. The

amount of net operating loss allocated to each period is reduced (but

not below zero) without regard to the section 382 limitation, first by

the modified capital gain net income remaining in the same period, and

then by the modified capital gain net income remaining in the other

period.

(d) Coordination with rules relating to the allocation of income

under Sec. 1.1502-76(b). If Sec. 1.1502-76 applies (relating to the

taxable year of members of a consolidated group), an allocation of

items under paragraph (a) or (b) of this section is determined after

applying Sec. 1.1502-76. Thus, if a short taxable year under

Sec. 1.1502-76 is a change year for which an allocation under this

section is to be made, the allocation under this section applies only

to the items allocated to that short taxable year under Sec. 1.1502-76.

(e) Allocation of certain credits. The principles of this section

apply for purposes of allocating, under section 383, excess foreign

taxes under section 904(c), current year business credits under section

38, and the minimum tax credit under section 53. The loss corporation

must use the same method of allocation (ratable allocation or closing-

of-the-books) for purposes of sections 382 and 383.

(f) Examples. The rules of this section are illustrated by the

following examples:

Example 1. (i) Assume that the loss corporation, L, a calendar

year taxpayer with a May 26, 1995, change date, determines a section

382 limitation under section 382(b)(1) of $100,000. Thus, for the

change year, its section 382 limitation is $100,000 x (219/

365)=$60,000. L makes the closing-of-the- books election under

paragraph (b) of this section.

(ii) Assume that L has a $150,000 capital loss carryover (from

its 1994 taxable year) and a $300,000 net operating loss carryover

(from its 1994 taxable year) to the change year. L recognizes, in

the pre-change period, $200,000 of ordinary loss, and, in the post-

change period, $150,000 of capital gain and $100,000 of ordinary

income. Assume that section 382(h) does not apply to the capital

gain or the ordinary income.

(iii) L has a $100,000 net operating loss for the change year

($200,000 pre-change loss less $100,000 post-change income), as

determined under paragraph (c)(1)(i) of this section. Because L has

no current year capital losses, L's $150,000 capital gain recognized

in the post-change period is its modified capital gain net income

for the change year (as defined at paragraph (g)(4) of this

section). L allocates $100,000 of net operating loss to the pre-

change period and $150,000 of modified capital gain net income to

the post-change period.

(iv) Under paragraph (c)(2)(i) of this section, L uses its

capital loss carryover to offset its modified capital gain net

income allocated to the post-change period, subject to its section

382 limitation. L's section 382 limitation is $60,000, so L uses

$60,000 of its capital loss carryover to offset $60,000 of its

$150,000 modified capital gain net income. L has absorbed its entire

section 382 limitation for the change year and has $90,000 of

modified capital gain net income remaining in the post-change

period.

(v) Under paragraph (c)(2)(ii) of this section, L offsets its

$100,000 net operating loss allocated to the pre-change period by

the $90,000 of modified capital gain net income remaining in the

post-change period, without regard to the section 382 limitation,

thereby reducing its pre-change net operating loss to $10,000.

(vi) From its 1994 taxable year, L will carry over $90,000 of

capital loss and $300,000 of net operating loss to its 1996 taxable

year. From its 1995 taxable year, L will carry over $10,000 of net

operating loss subject to the section 382 limitation to its 1996

taxable year.

Example 2. (i) Assume the facts of Example 1, except that L does

not make the closing-of-the-books election under paragraph (b) of

this section.

(ii) L ratably allocates its $100,000 net operating loss and its

$150,000 of modified capital gain net income for the change year.

$40,000 of net operating loss ($100,000 x (146/365)) and $60,000

of modified capital gain net income ($150,000 x (146/365)) are

allocated to the pre-change period. $60,000 of net operating loss

($100,000 x (219/365)) and $90,000 of modified capital gain net

income ($150,000 x (219/365)) are allocated to the post-change

period.

(iii) Under paragraph (c)(2)(i) of this section, L uses its

capital loss carryovers to offset modified capital gain net income.

The capital loss carryovers offset the $60,000 modified capital gain

net income allocated to the pre-change period without limitation.

Subject to the section 382 limitation, the remaining $90,000 of

capital loss carryovers offset the modified capital gain net income

allocated to the post-change period. Accordingly, L uses $60,000 of

its capital loss carryovers to offset $60,000 of its $90,000

modified capital gain net income allocated to the post-change

period. L has absorbed its entire section 382 limitation for the

change year.

(iv) Under paragraph (c)(2)(ii) of this section, L's $60,000 net

operating loss allocated to the post-change period is offset by its

remaining $30,000 of post-change modified capital gain net income,

reducing its post-change net operating loss to $30,000.

(v) From its 1994 taxable year, L will carry over $30,000 of

capital loss and $300,000 of net operating loss to its 1996 taxable

year. From its 1995 taxable year, L will carry over $70,000 of net

operating loss ($40,000 pre-change +$30,000 post-change) to its 1996

taxable year. The $40,000 pre-change portion of that carryover is

subject to the section 382 limitation.

(g) Definitions and nomenclature. The terms and nomenclature used

in this section and not otherwise defined herein have the same meanings

as in sections 382 and 383 and the regulations thereunder. For purposes

of this section:

(1) Change year. A loss corporation's taxable year that includes

the change date is its change year.

(2) Pre-change period. The pre-change period is the portion of the

change year ending on the close of the change date.

(3) Post-change period. The post-change period is the portion of

the change year beginning with the day after the change date.

(4) Modified capital gain net income. A loss corporation's modified

capital gain net income is the excess of the gains from sales or

exchanges of capital assets over the losses from such sales or

exchanges for the change year, determined by excluding any short-term

capital losses under section 1212.

(h) Effective date. This section applies to ownership changes

occurring on or after June 22, 1994.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as

follows:

Authority: 26 U.S.C. 7805.

Sec. 602.101 [Amended]

Par. 5. Section 602.101(c) is amended by adding the entry ``1.382-

6. . . .1545-1381'' in numerical order to the table.

Dated: June 2, 1994.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved:

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 94-14970 Filed 6-21-94; 8:45 am]

BILLING CODE 4830-01-U