Consolidated ReturnsStock Basis and Excess Loss Accounts, Earnings and Profits, Absorption of Deductions and Losses, Joining and Leaving Consolidated Groups, Worthless Stock Loss, Nonapplicability of Section 357(c)
Federal RegisterAug 15, 1994
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8560]
RIN 1545-AQ69
Consolidated Returns--Stock Basis and Excess Loss Accounts,
Earnings and Profits, Absorption of Deductions and Losses, Joining and
Leaving Consolidated Groups, Worthless Stock Loss, Nonapplicability of
Section 357(c)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations amending the
consolidated return investment adjustment system, including the rules
for earnings and profits and excess loss accounts. The amendments
delink the adjustments to stock basis from the adjustments to earnings
and profits. Stock basis is adjusted under rules similar to the rules
for adjusting the basis of partnership interests and stock in S
corporations, and earnings and profits are adjusted under a separate,
parallel system. Amendments are also made to the rules limiting
absorption of a member's deductions and losses when it leaves a
consolidated group, modifying the stock basis and earnings and profits
of members in certain group structure changes, allocating a
corporation's tax items for the year it joins or leaves a consolidated
group, allowing a worthless stock loss deduction with respect to the
stock of members, and applying section 357(c) to transactions between
members.
DATES: These regulations are effective January 1, 1995.
For dates of applicability, see the ``Effective dates'' section
under the SUPPLEMENTARY INFORMATION portion of the preamble.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations relating to
stock basis, excess loss accounts, and earnings and profits generally,
absorption of deductions and losses, worthless stock loss and the
nonapplicability of section 357(c), Steven B. Teplinsky, (202) 622-
7770; concerning the regulations relating to group structure changes,
Rose L. Williams (202) 622-7550; and concerning the regulations
relating to the allocation of items for the year a corporation joins or
leaves a group, Roy A. Hirschhorn, (202) 622-7770. (These numbers are
not toll-free numbers.)
SUPPLEMENTARY INFORMATION:
A. Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the requirements of the Paperwork Reduction Act (44
U.S.C. 3504(h)) under control number 1545-1344. The estimated average
annual burden per respondent is .6 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP,
Washington, DC 20224, and 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.
B. Background
This document contains final regulations for adjusting the stock
basis and earnings and profits (E&P) of members of consolidated groups,
and related rules.
Proposed regulations were issued in a Notice of Proposed Rulemaking
published in the Federal Register on November 12, 1992. See 57 FR
53634. In addition to the originally scheduled public hearing, a second
hearing was scheduled in a Notice of Additional Public Hearing on
Proposed Regulations published in the Federal Register on November 23,
1992. See 57 FR 54957. In Notice 92-59, 1992-2 C.B. 386, the IRS
delayed the repeal of the 30-day rules so that they would continue to
apply to corporations becoming or ceasing to be members before February
15, 1993.
The IRS received many comments on the proposed regulations
addressing both policy and technical matters, and held public hearings
on December 18, 1992 and March 4, 1993. After consideration of the
comments and the statements made at the hearings, the proposed
regulations are adopted as modified by this Treasury decision. The
modifications, as well as several comments and suggestions that are not
adopted in the final regulations, are discussed below.
No inference is intended by the final regulations as to the
operation of the current regulations.
C. The Proposed and Final Regulations
The final regulations retain the general approach of the proposed
regulations, delinking stock basis adjustments from E&P adjustments and
operating through uniform rules of general application rather than
through mechanical rules. However, numerous changes have been made to
clarify the regulations and to conform their style to that of other
recent consolidated return regulations.
1. Delinking Stock Basis and E&P
The investment adjustment system of the current regulations
requires an owning member (P) to adjust its basis in the stock of a
subsidiary (S) to reflect S's current E&P (or E&P deficit). P's basis
is also generally reduced by the amount of any dividend distributions
by S to P. The adjustments have the effect of treating P and S as a
single entity. To the extent E&P includes amounts such as tax-exempt
interest income, the adjustments prevent the income from being taxed
indirectly on the disposition of S's stock.
After S's E&P is taken into account by P in adjusting its basis in
S's stock, the stock basis adjustment is taken into account to adjust
P's own E&P. This adjustment ensures that S's E&P is taken into account
by P for purposes of further stock basis adjustments if P is not the
common parent, and for distributions by P to nonmembers.
The current regulations were adopted in 1966. It was appropriate at
that time to link stock basis and E&P adjustments because the
modifications to taxable income required to compute E&P were generally
also necessary to compute stock basis. Differences between taxable
income and E&P have substantially increased since 1966, however, and
many changes in the rules for determining E&P are not appropriate to
the determination of stock basis. The resulting confusion and conflict
is evidenced by recent cases examining the investment adjustment
system.
Section 1503(e) corrects many investment adjustment distortions
resulting from the divergence of taxable income and E&P. It requires P
to redetermine its basis in S's stock under modified rules at the time
the stock is disposed of. The modifications eliminate the original
rationale for a system linking stock basis to E&P. Moreover, because
the modifications are not generally integrated into the investment
adjustment regulations, significant complexity has resulted.
The proposed regulations comprehensively revise the investment
adjustment system by delinking stock basis adjustments from E&P
adjustments. Stock basis adjustments are determined by reference to a
modified computation of S's taxable income, rather than to S's E&P. S's
E&P continues to tier up to P, but under a separate E&P adjustment
system. Separating the stock basis and E&P adjustment systems
implements the intent of section 1503(e) and prevents policies specific
to one system from distorting the other.
Some commentators argued that the current E&P-based system is
simpler because it is familiar to practitioners, even though it
requires taxpayers to determine investment adjustments first by
reference to E&P, then by incorporating modifications under current
regulations, and finally by incorporating modifications under the Code.
These commentators contended that the effect of transactions on E&P was
usually clear, and that changing the system resulted in more, rather
than less, uncertainty. Most commentators, however, agreed that
delinking stock basis and E&P is appropriate.
The E&P system is fundamentally concerned with measuring dividend
paying capacity, while the investment adjustment system is concerned
with measuring consolidated taxable income. The current system is
overly complex because it provides different rules for different
sources of E&P, the effect of many transactions on E&P is uncertain,
and the E&P rules are already overridden by temporary consolidated
return regulations and later enacted Code provisions. By contrast,
proper investment adjustments for most subsidiaries under the proposed
regulations generally will equal the change in the subsidiary's net
asset basis for tax purposes during the period that it is a member.
One example of the distortions under the current regulations is the
effect of S's unabsorbed loss on P's E&P. The positive investment
adjustment for unabsorbed losses correctly prevents P's basis in S's
stock from being reduced while the loss is carried over. However,
because P's E&P is adjusted by the amount of the adjustment to P's
basis in S's stock, the adjustment also has the effect of preventing
P's E&P from reflecting S's loss even though the dividend paying
capacity of the group has diminished. Thus, the proper timing of stock
basis and E&P adjustments is in conflict. The distortion is increased
if the amount of S's tax loss and E&P deficit do not correspond, and
uncertainty is created if the loss has a special status.
Investment adjustments under the proposed regulations generally are
based on items calculated annually and reflected in a taxpayer's tax
return or permanent records, rather than on E&P items that may never
have been calculated or recorded. Although the current regulations
require taxpayers to adjust stock basis annually, annual E&P
computations are otherwise generally unnecessary and commentators
generally agree that most groups fail to make the adjustments annually.
If stock basis adjustments are not determined until stock is to be
disposed of, costly E&P studies are required to calculate items from
prior periods for which records may no longer be available.
Even if S attempts to calculate its E&P annually for purposes of
the current regulations, that calculation is subject to uncertainty in
many cases despite the development over the years of a substantial body
of E&P guidance. See, e.g., section 312(h) and Secs. 1.312-10 and
1.312-11 (E&P allocations in corporate separations and
reorganizations). New transactions and Code provisions continue to
develop and require E&P guidance.
Because the proposed regulations delink stock basis and E&P
determinations, the policies influencing the development of E&P rules
no longer affect the unrelated and potentially conflicting policies for
stock basis adjustments. Section 1503(e) already mandates separate
computations for purposes of adjusting stock basis and E&P, and the
growing disparity between taxable income and E&P may preclude taxpayers
from relying on E&P guidance in many instances. See, e.g., section
1503(e)(1)(B). Consequently, the best approach to the investment
adjustment system is to begin the computation with taxable income or
loss and make adjustments. Compare the systems for adjusting the basis
of partnership interests (section 705) and stock in S corporations
(section 1367).
The final regulations retain the approach of the proposed
regulations. Investment adjustments are determined by reference to (i)
taxable income or loss, (ii) tax-exempt income, (iii) noncapital,
nondeductible expenses, and (iv) distributions.
2. Taxpayers' Ability To Override Specific Rules
Many of the proposed regulation sections begin with a general
statement of the purposes of the section. Most commentators supported
these statements. Commentators suggested that taxpayers should be able
to use them to override specific rules (i) in general, (ii) if failure
to override would result in duplicating items, (iii) if the taxpayer
discloses the override in its return, or (iv) if the taxpayer receives
an expedited ruling from the IRS expressly allowing the override (under
procedures to be established). Some commentators suggested that the IRS
should also have the authority to override specific rules in certain
circumstances, and that the circumstances justifying an IRS override
could be broader than those justifying a taxpayer override.
The proposed statements of purposes were intended to prevent the
recurrence of historic problems associated with literal application of
the consolidated return regulations, and they are retained in the final
regulations. However, commentators expressed a diversity of views as to
how the regulations could be interpreted to serve taxpayer purposes.
Consequently, the final regulations do not authorize taxpayers to
deviate from specific rules, except to prevent duplication of
adjustments. For example, a negative stock basis adjustment is not made
under section 301(c)(2) if the adjustment has already been taken into
account under the final regulations.
The proposed regulations also contain statements describing rules
of construction and identify factors to be weighed in making
adjustments. Commentators requested that these statements and factors
be clarified. The statements and factors are not retained in the final
regulations because they merely restate generally applicable rules of
construction. The final regulations remain subject to generally
applicable rules of construction.
3. Negative Adjustments
In addition to reducing stock basis for tax losses, the proposed
regulations reduce stock basis for noncapital, nondeductible amounts
such as Federal income taxes, and for distributions. The IRS received
numerous comments on specific applications of these adjustments,
particularly the negative adjustments for expiring losses and for
distributions of E&P from years when S was affiliated with P but filed
separate returns.
The proposed regulations provide that noncapital, nondeductible
expenses result in negative adjustments. Like positive adjustments for
tax-exempt income, these negative adjustments are necessary to preserve
the treatment of items under the Code. Similar treatment is required
for certain direct, permanent adjustments to the basis of S's assets.
For example, a reduction in the basis of S's assets under section 50(c)
must be reflected by a corresponding reduction in P's basis in S's
stock.
a. Expiring Losses
Many comments were received on the negative adjustment for the
expiration of S's loss carryovers. Commentators generally agreed that
losses arising while S is a member of the group should be treated as
noncapital, nondeductible amounts in the year they expire, but
disagreed with this treatment for losses that arose before S became
affiliated with P.
For example, if P forms S with a $100 capital contribution and S
generates a $60 net operating loss (NOL) carryover, P's basis in S's
stock remains $100 under the proposed regulations. If the NOL
subsequently expires under section 172, the expiration is a noncapital,
nondeductible expense upon the expiration because S's loss is
effectively disallowed at that time. P's basis in S's stock must be
reduced to prevent the loss from effectively being preserved in the
basis. Commentators generally agreed with this result, and it conforms
to the results for partners and S corporation shareholders whose loss
carryovers expire.
If instead P buys existing S stock for $100, and at that time S's
assets have a $40 basis and value and S has a $60 NOL, many
commentators argued that P's $100 cost basis in the S stock does not
reflect the $60 NOL and that the NOL's subsequent expiration therefore
should not reduce P's basis in the S stock (or should reduce basis only
to a limited extent). No principles have been identified to distinguish
an expiring NOL from other noncapital, nondeductible amounts that
reduce P's basis in S's stock. Moreover, no meaningful distinction has
been found between the case in which S has a separate built-in loss (in
the form of the NOL) that corresponds to its built-in gain and the case
in which S has no built-in loss or gain at the time of P's acquisition
and S subsequently produces corresponding gain and an NOL that expires.
Some commentators acknowledged that, if S has a $60 NOL and $60 of
corresponding built-in gain, as much as $21 of P's cost basis in S's
stock may reflect the NOL (35% of $60), but suggested that much less
than $21 is likely to be reflected, particularly if the use of the NOL
is limited under section 382. These commentators suggested that the
analysis should shift to determining possible after-tax benefits of the
NOL to the P group that might be reflected in P's cost basis in S's
stock (i.e., P's negative adjustment would be limited to the amount
paid by P for the NOL--an amount not to exceed $21).
The final regulations do not adopt this suggestion. Determining
after-tax amounts accurately is inherently complex. In addition, there
is no apparent reason why adjustments for absorption of the NOL should
differ from those for expiration of the NOL, or why subsequent positive
adjustments for S's built-in gain should not also increase basis by
only an after-tax amount. For example, although S's $60 built-in gain
would be fully subject to tax following repeal of the General Utilities
doctrine, commentators did not suggest that P's basis should be
increased by only $39 for the gain (65% of $60, or $60 minus a $21
discount in the purchase price of the S stock to reflect the built-in
tax).
Almost all commentators argued that a negative adjustment is
inappropriate in some cases. For example, if P buys existing S stock
for $40, and at that time S's assets have a $40 basis and value and S
has a $60 NOL, commentators argued that the expiration of the NOL
should not reduce P's basis in the S stock (to a $20 excess loss
account) because P's $40 cost basis in the S stock does not reflect the
$60 NOL.
Commentators identified the following general cases in which a
negative adjustment may be warranted: (i) if S incurs the loss after P
purchases the S stock (because P's basis in the stock reflects an
amount corresponding to the NOL); (ii) if P acquires S stock in a
carryover basis transaction (because P may succeed to a prior
shareholder's stock basis reflecting the NOL); and (iii) if P
indirectly acquires S stock by purchasing S's parent (because the
parent's basis in S's stock may reflect the NOL).
The proposed regulations do not predicate stock basis adjustments
on presumptions as to whether amounts are already reflected in stock
basis. Instead, they reflect the treatment under the Code of all
changes in S's net asset basis while S is a member. Substantially
altering this approach to take additional information into account
would require significant modifications, including appraisals and
tracing.
Nevertheless, the IRS and the Treasury Department believe that
certain cases merit relief. For example, if P buys S's stock and S has
a large NOL carryover subject to a section 382 limitation, expiration
of the NOL could easily result in an unavoidable negative adjustment
even though the NOL was of limited value. Solutions suggested by
commentators included (i) never providing a negative adjustment (even
if the NOL arises in P's group) because there is no tax benefit for the
expiration, (ii) limiting the negative adjustment to $.35 for every $1
of NOL (based on the highest marginal tax rate), (iii) requiring a
negative adjustment only if S becomes a member after the proposed
regulations are finalized (or only if the NOL expires after the
proposed regulations are finalized), (iv) limiting the negative
adjustment to prevent it from reducing P's basis in S's stock below S's
net asset basis immediately after the expiration, and (v) permitting P
to waive S's NOL before S becomes a member (thereby preventing the NOL
from expiring while P owns S).
The final regulations generally retain the proposed rule requiring
a negative stock basis adjustment for expiring losses. However, the
final regulations provide a special rule allowing an acquiring group to
waive S's loss carryovers from separate return limitation years. In
addition, if S became a member of a group before the effective date of
the final regulations and had a loss carryover from a separate return
limitation year at that time, a special rule provides that the group is
not required to treat expiration of the loss carryover as a negative
adjustment under this section (although if S becomes a member of a
second group after the effective date and the loss carryover expires
while S is a member of the second group, the special rule does not
apply).
To more fully integrate expired losses into the investment
adjustment system, the final regulations also add special rules
treating expired loss carryovers as continuing to exist for purposes of
determining whether a positive adjustment is permitted for cancellation
of indebtedness income and whether an excess loss account must be taken
into account because of S's worthlessness.
To waive a loss carryover, the final regulations require the group
to identify the amount waived (or the amount not waived) in a statement
filed with the group's consolidated return for the year S becomes a
member. The group may waive any carryover that it chooses, and may
waive amounts carried from different years. However, the final
regulations do not permit groups to identify the waived amount (or the
unwaived amount) through formulas. Comments are solicited as to whether
the use of formulas should be permitted and as to any other rules that
should be adopted in subsequent IRS guidance.
b. Adjustments for All Distributions
Because stock basis adjustments under the proposed regulations
generally conform to changes in S's net asset basis, and S's
distribution of $1 always decreases S's net asset basis by $1, the
proposed regulations require that all distributions by S reduce P's
basis in S's stock. By contrast, the current regulations do not reduce
basis for distributions of E&P earned in affiliated, nonconsolidated
years. Because the proposed rule is a significant change from current
law, the proposed regulations require negative adjustments for
distributions of this E&P only if the distribution is made after the
proposed regulations are adopted.
Many commentators argued that no negative adjustment should be
required for distributions by S of E&P from affiliated, nonconsolidated
years. They viewed the approach of the current regulations as
preferable because (i) no positive adjustment is made when the E&P is
earned, (ii) sections 243 and 1502 were intended to reach comparable
results for nonconsolidated and consolidated groups with respect to
affiliated, nonconsolidated E&P, and section 243 allows a 100%
dividends received deduction to nonconsolidated groups without a basis
reduction, and (iii) section 1059 was intended by Congress to be the
only source of additional basis reductions. Moreover, although
taxpayers could avoid the proposed negative adjustment by making a
distribution during the last separate return year, commentators
maintained that the proposed negative adjustment was a trap for
taxpayers unable or unwilling to make distributions before joining in a
consolidated return.
Commentators advocated preserving the approach of the current
regulations by providing an exception for distributions of E&P
accumulated in affiliated, nonconsolidated years. Such an exception
would require determining the amount of modified taxable income for
investment adjustment purposes that corresponds to the E&P, and
providing rules relating that income to the distributed E&P. Although
section 301(e) already modifies the applicable E&P, additional
modifications would be required to determine the modified taxable
income under the proposed regulations for particular subsidiaries.
Preserving separate return treatment for distributions during
consolidated return years is increasingly inappropriate as more
distinctions are made under the Code and regulations between
corporations filing separate and consolidated returns. The proposed
regulations maintain the distinctions between separate and consolidated
returns by effectively preserving the separate return double tax system
for E&P not distributed in separate return years.
The absence of a negative adjustment under the current regulations
appears to be based on a presumption that the distributed E&P is not
reflected in stock basis. This presumption may be wrong if, for
example, P purchases S's stock after the E&P economically accrues but
before it is taken into account for Federal income tax purposes. To
limit the negative adjustment would be inconsistent with the general
approach of the regulations because it would require appraisals and
tracing of E&P to provide different stock basis reductions depending on
the nature of the distributed E&P.
Commentators also suggested that requiring a negative adjustment
for distributions could be appropriate if the regulations also provided
that P's basis in S's stock was automatically or electively adjusted in
S's first consolidated return year to reflect S's E&P from affiliated,
nonconsolidated years. Where taxpayers fail to make distributions in
consolidated return years, however, the adjustment would have the
effect of positive investment adjustments for earnings in separate
return years even though the consolidated return rules do not generally
apply to those years. This approach would have the effect of
inappropriately applying a portion of the consolidated return rules to
periods for which separate returns are filed.
Accordingly, the final regulations retain the requirement of a
negative stock basis adjustment for all distributions. However, S's
stock basis is not reduced as a result of a distribution of E&P
accumulated in separate return years, if the distribution is made in a
tax year beginning before January 1, 1995 and the distribution does not
cause a negative adjustment under the investment adjustment rules in
effect at the time of the distribution.
4. Allocation of Adjustments
The proposed regulations provide limited rules for allocating stock
basis adjustments to different shares of stock. Allocation issues arise
if, for example, P owns less than all of S's stock, S has more than one
class of stock, P's interest in S varies, or P has different bases in
different blocks of S's stock.
The allocation rules of the proposed regulations are similar in
effect to those of the current regulations. Under the proposed
regulations, however, stock basis adjustments must be cumulatively
redetermined whenever necessary to determine the tax liability of any
person.
Most commentators agreed that the proposed allocation rules provide
greater guidance than the current regulations. Commentators had mixed
views on the proposed cumulative redetermination rule. Some stated that
cumulative redeterminations are complex, but are nevertheless
economically sound and appropriate. Others stated that taxpayers should
not be required to redetermine their basis because the requirement is
inconsistent with the proposed annual basis adjustment statement and
imposes undue administrative difficulties on taxpayers. However,
specific problems that would commonly result in undue difficulties were
not identified.
The final regulations retain the allocation system of the proposed
regulations, including the cumulative redetermination rule, but provide
additional guidance for cumulative redeterminations. See ``Annual
reporting requirement,'' discussed at C.7. of this preamble, for the
elimination of the annual reporting requirement.
5. Election to Reallocate Basis
The current regulations provide that if P disposes of S stock with
an excess loss account, P may avoid including the excess loss account
in income by electing to reduce its basis in any retained S stock or
debt by an amount equal to the excess loss account. This election was
substantially limited by section 1503(e)(4) and by recent amendments to
the consolidated return regulations, and its remaining scope is
unclear.
The proposed regulations eliminate the election. Negative
adjustments (other than for distributions) are not allocated to
preferred stock because of its similarity to debt, which receives no
negative adjustments. S's losses should not be allocated to preferred
shares until S is unable to satisfy their priority. S's ability to
satisfy their priority can only be determined with appraisals, and the
use of appraisals is contrary to the general approach of the
regulations.
Commentators requested that the election be retained. The most
common use of the election is where P holds both common and preferred
stock of S, because all of S's negative adjustments are allocated to
its common stock. The rationale for an election in these cases is to
permit P to avoid income from an excess loss account in the common
stock that may be attributable to P's investment in the preferred
stock.
However, P's investment in S's preferred stock is distinct from its
investment in common stock. If negative adjustments should not be
initially allocated to the preferred stock (or reallocated on a
cumulative redetermination), they should not effectively be reallocated
to the preferred stock through an election.
In view of the limited scope of the election, the increased ability
of the allocation rules to reflect economic interests, and the
limitations on allocating negative adjustments to preferred stock, the
final regulations continue the approach of the proposed regulations and
eliminate the basis reallocation election of current law.
6. Anti-Avoidance Rules
The proposed investment adjustment regulations require overriding
adjustments to carry out the purposes of the regulations if any person
acts with a principal purpose to avoid the effect of the regulations,
or uses the regulations to avoid the effect of any other provision of
the consolidated return regulations. More specific rules are provided
to take into account any difference between the basis and value of
property transferred to (or from) S, and to continue making adjustments
if a corporation becomes a nonmember. Commentators criticized the
uncertainty caused by the proposed overriding adjustment rules.
Anti-avoidance rules are necessary if the regulations are to
operate through uniform rules of general application that are subject
to interpretation and juxtaposition with other rules. Because the
purposes of the regulations are identified, taxpayers generally should
be aware of inappropriate results. Limiting circumvention of the
regulations through transactions having a principal purpose of
avoidance is consistent with other recent consolidated return guidance
and with regulations issued under Code provisions applicable to
separate return taxpayers.
The final regulations retain the general approach of the proposed
regulations but operate through a single rule. Many of the proposed
examples are modified to reflect comments, and examples of permitted
avoidance of the rules are added. In the new examples, all relevant
aspects of the transactions take place under separate return rules, so
that avoidance of the regulations is not inconsistent with the purposes
of the regulations.
7. Annual Reporting Requirement
To ensure more accurate determinations of stock basis adjustments,
the proposed regulations require that a statement be included in each
year's return identifying the adjustments for that year. This annual
reporting requirement was proposed because of the concern that most
groups do not determine the amount of their investment adjustments
annually as required by the current regulations and do not maintain
adequate records to make accurate determinations at a later date.
Ultimately, these groups determine stock basis through elaborate but
often unreliable E&P studies performed in connection with a later stock
disposition.
Commentators differed in their views on the proposed annual
reporting requirement. While some agreed that the additional burden was
worth the potential improvement in compliance with the annual
adjustment requirement and in the accuracy of the adjustments, others
contended that the information contained in the annual statements would
not be useful. They asserted that (i) the reporting would be burdensome
because it would be required for all subsidiaries even though many
would never be disposed of, (ii) collecting information relevant only
for future determinations of tax liability would do little to improve
the accuracy of investment adjustments, and (iii) the lack of a
noncompliance penalty would lead to noncompliance with the reporting
requirement or to faulty reporting.
The final regulations do not retain the proposed annual reporting
requirement. The elimination of the proposed reporting requirement does
not, however, reflect acceptance of the view that taxpayers need not
make investment adjustments annually. There is continuing concern that
investment adjustments often are not determined with reasonable
accuracy, particularly in the case of long-held subsidiaries.
To increase the accuracy of investment adjustment determinations
(and the ability to examine the group's returns based on those
determinations), the final regulations expressly require taxpayers to
maintain annual books and records necessary for accurate stock basis
adjustments. This requirement is consistent with section 6001, which
generally requires taxpayers to keep those records that the Secretary
deems necessary to determine tax liability. Taxpayers are cautioned
that they are subject to penalties for tax underpayments resulting
from, among other things, negligence or substantial or gross
misstatements of the adjusted basis of any property (including stock of
subsidiaries). See, e.g., section 6662 (c), (e), and (h).
8. E&P Adjustments
a. General Rules
The proposed regulations tier up E&P directly from S to P under a
system separate from, but parallel to, the stock basis adjustment
system. By separating the two systems, the possibility of phantom E&P
adjustments resulting from the stock basis rules is eliminated.
If S earns E&P in a consolidated return year, the E&P tiers up
under the proposed regulations directly and is included in P's E&P. If
S later distributes the E&P to P, P's E&P does not further increase
because P's dividend income is offset by a decrease for the tier up of
S's E&P reduction under section 312 from the distribution.
The proposed regulations generally did not intend to permit the
complete elimination of S's E&P from affiliated, nonconsolidated years
by offsetting P's dividend income with S's E&P reduction from the
distribution. S's affiliated, nonconsolidated E&P was not included in
P's E&P when earned (because no tier up occurs in affiliated,
nonconsolidated years), and if it is not included in P's E&P when
distributed, it would be eliminated entirely. Commentators questioned
this result because it cannot be achieved under the Code if separate
returns are filed and is inconsistent with both single entity and
separate entity treatment of P and S.
Both the current and the proposed regulations permit E&P
distributed by S to be eliminated if the E&P was earned in years before
S became affiliated with P (SRLY E&P). Elimination of SRLY E&P is also
possible under separate return rules. Because P generally has no
negative stock basis adjustment for separate return distributions by S,
P's E&P from the dividend ultimately may be offset by an E&P deficit
(or less E&P) from a later disposition of S's stock. Whether the
elimination of SRLY E&P is correct depends on the extent to which the
E&P is already reflected in P's E&P. However, the elimination of
affiliated, nonconsolidated E&P is incorrect.
The final regulations generally retain the approach of the proposed
regulations. However, the final regulations provide additional rules to
prevent the elimination of S's affiliated, nonconsolidated E&P by its
distribution to P during a consolidated return year.
b. Dividend Stripping
Several rules of the proposed regulations limit P's ability to
obtain unintended tax benefits by avoiding negative basis adjustments
for certain distributions from S while claiming the dividends received
deduction for the distributions. For example, (i) P takes into account
S's distribution to which section 301 applies when P becomes entitled
to the distribution (generally on the record date), (ii) S's E&P is
eliminated immediately before S becomes a nonmember to the extent the
E&P is reflected by another member under the proposed regulations, and
(iii) if P succeeds another corporation as the common parent of a
group, P's E&P is adjusted immediately after it becomes the new common
parent to reflect the E&P of the former common parent.
The final regulations retain the approach of the proposed
regulations. However, the final regulations apply the distribution
entitlement rule for all Federal income tax purposes (not just for
purposes of stock basis and E&P adjustments). Expansion of the rule is
consistent in many respects with current Sec. 1.1502-32(k).
Because the final regulations retain the proposed entitlement rule
for all Federal income tax purposes, S's E&P is reduced at the time P
becomes entitled to a distribution from S. Applying the entitlement
rule for E&P purposes is consistent with its application for stock
basis adjustments and is necessary to prevent distortions in the amount
of S's E&P when S leaves the group.
For example, assume that S has $50 of E&P from separate return
years and $30 of current consolidated return year E&P. If S distributes
$30 to P before becoming a nonmember, this distribution is treated as
being made out of consolidated E&P. Thus, S's consolidated E&P is
reduced to $0 and S continues to have $50 of accumulated E&P as a
nonmember. Applying the entitlement rule for E&P purposes ensures
consistent results for any distribution to which P becomes entitled
while S is a member. Otherwise, S's $30 of consolidated E&P would be
eliminated under the final regulations when S becomes a nonmember, and
its $50 of accumulated E&P would be reduced by the amount of the
distribution (to $20) due to a delay of the dividend payment until
after S becomes a nonmember.
In addition, the final regulations retain and clarify the current
rules for making proper adjustments to E&P where the location of a
member other than the common parent changes within the group.
c. Tax Sharing Agreements
The current and the proposed regulations permit groups to elect to
treat as a tax liability any amounts owing from one member to another
as compensation for the absorption of tax attributes. The proposed
regulations also require compensating amounts to be reflected for
purposes of determining stock basis adjustments. In response to
comments, the final regulations permit groups to conform the
determination of E&P to the amounts reflected in stock basis.
9. Circular Basis Adjustments
The ``circular basis'' provisions of the current regulations limit
the use of S's deductions and losses to offset P's gain from the sale
of S stock. Without these rules, the absorption of S's losses would
reduce P's basis in S's stock under the stock basis adjustment rules
and thereby correspondingly increase P's gain on the stock sale.
Ultimately, S's losses could be completely absorbed without reducing
the net amount of P's gain on the stock sale.
The proposed regulations generally restate and clarify the current
rule, and continue to prevent S's losses from offsetting P's gain from
the sale of S stock. The proposed regulations expand the current rule
to prevent losses of S's wholly owned subsidiary from offsetting P's
gain from the sale of S stock, because absorption of these losses
similarly reduces the basis of S's stock and correspondingly increases
P's gain.
Commentators suggested that the limitation be further expanded to
include brother-sister cases. If P owns all of the stock of S1 and S2,
the proposed regulations do not limit the use of S1's losses against
P's gain from the sale of S2 stock or the use of S2's losses against
P's gain from the sale of S1 stock. The final regulations do not extend
the limitation because these cases cannot readily be distinguished from
cases to which commentators believe the rules should not apply, and
from cases in which some taxpayers would be disadvantaged.
Assume that P owns the stock of S1 with a $100 basis and $100
value, and the stock of S2 with a $100 basis and $150 value. S1 has a
$20 NOL and S2's assets have a $100 basis. In Year 1, P sells S2's
stock at a $50 gain, S1's NOL offsets $20 of P's gain, and use of the
NOL reduces P's basis in S1 from $100 to $80. In Year 2, P sells S1 at
an additional $20 gain. The group's aggregate gain in Years 1 and 2 is
$50, and S's NOL is effectively eliminated.
Although many commentators suggested that S1's NOL be limited if
its stock is also sold in Year 1, none suggested that the NOL be
limited if S1's stock is sold in a later year. In addition, none
suggested that S1's NOL be limited in Year 1 if P causes S2 to sell its
assets rather than selling the S2 stock.
The suggested extension of the current limitation would be
unfavorable to P if, for example, P had a $120 basis in S1's stock and
the $20 loss inherent in the S1 stock could not be deducted under
Sec. 1.1502-20. Extending the limitation would prevent the group from
offsetting S1's NOL against S2's taxable income merely to preserve P's
stock loss that will be disallowed.
The final regulations retain the proposed rules.
10. Group Structure Change Rules
The proposed regulations expand the rules of current temporary
regulations for determining stock basis and E&P in certain group
structure changes. For example, if P is the common parent and its
shareholders form a holding company (H) by transferring their P stock
to H in a transaction to which section 351 applies, the transaction is
a group structure change and H's basis in the P stock is determined
under the current regulations by reference to the net basis of P's
assets (rather than the basis of P's former shareholders in their P
stock). The proposed regulations expand the scope of the current rules
by including group structure changes that involve recognition
transactions and by requiring only a 50% continuity of shareholders
(rather than 80%), because the existence of the group is preserved in
these transactions.
Commentators criticized the expansion of the current rules. Some
argued that the rules should not be extended to taxable transactions
because those transactions do not represent a mere rearrangement of the
group's structure. However, the extension is consistent with the
general approach of the current regulations to preserving the group's
identity, and taxable transactions are indistinguishable for this
purpose from nonrecognition transactions that were preceded by taxable
transactions.
Commentators also suggested that P's NOLs should be treated as
additional basis in determining P's net asset basis. This approach was
not followed in the proposed regulations because additional rules would
have been required if an NOL could be duplicated in H's basis in P's
stock (e.g., if the NOL is subject to limitation under section 382).
The final regulations retain the approach of the proposed
regulations but, in response to comments, allow the group to waive any
loss carryovers of the former common parent immediately before the
group structure change. The waiver is intended to permit groups to
avoid later negative adjustments to H's basis in P's stock from the
expiration of the loss carryovers.
11. Elimination of the 30-day Rules
The proposed regulations (together with Notice 92-59) eliminate the
30-day rules under the current regulations for corporations becoming or
ceasing to be members on or after February 15, 1993. The 30-day rules
were intended to be rules of administrative convenience. However, they
create numerous inconsistencies that are not easily resolved, can lead
to substantial complexity, and create unintended tax planning
opportunities.
Many problems are raised by the 30-day rules. The rules apply only
for purposes of the consolidated return regulations and therefore may
conflict with rules under the Code that rely on precise timing (e.g.,
the effective date of a statutory provision applicable to acquisitions,
or the date of an ownership change under section 382 resulting from
joining or leaving a group). The rules may result in anomalies (e.g.,
if an historic member liquidates within the first 30 days of the
group's year, taxpayers may argue that the member could deconsolidate
itself for the short year ending with the liquidation). The recast of
the 30-day rules may conflict with other recasts under the Code (e.g.,
if P acquires S's stock in a section 338(g) transaction, accelerating
the inclusion of S in the P group to before the qualified stock
purchase is inconsistent with section 338 policy, which does not permit
S's gain on the deemed asset sale to be included in the P group's
return). The 30-day rules could affect the results of virtually any
transaction between S and another member of the selling or buying group
during the 30-day period (e.g., if S distributes a lower-tier member's
stock to its parent before P's acquisition of S's stock, it is unclear
whether the 30-day rules could cause S's distribution to be treated as
made from the P group).
Several alternatives were considered in developing the proposed
regulations, but each alternative presented additional problems. It is
not feasible to apply the 30-day rules uniformly under the Code because
of the many conflicts that arise whenever the ownership of S's stock is
treated as other than where the benefits and burdens of stock ownership
reside. Accordingly, the final regulations continue the approach of the
proposed regulations, but eliminate the 30-day rules only for
subsidiaries that become or cease to be members of consolidated groups
on or after January 1, 1995.
To ameliorate the administrative burdens of eliminating the 30-day
rules, the final regulations allow taxpayers to use new simplified
rules for allocating items to the short period that the 30-day rules
eliminate. The final regulations further simplify item allocations by
permitting taxpayers to prorate a target's items for the month of its
acquisition or disposition. Guidance is being considered that
identifies circumstances in which a stock acquisition formally
occurring on one date may be treated for all Federal income tax
purposes as occurring as of another date, if the benefits and burdens
of ownership are transferred on the other date.
12. Miscellaneous Changes
a. Intercompany Transaction Rules
The final regulations move certain basis rules from Sec. 1.1502-31
to the related provisions in Secs. 1.1502-13 and 1.1502-14. These
changes were not included in the proposed regulations because they were
to be more fully considered in connection with revisions to the
intercompany transaction system. See CO-11-91, 59 FR 18011. No
inference should be drawn from the relocation of these rules, which is
now necessary because the proposed investment adjustment rules are
being finalized before the proposed intercompany transaction rules.
b. Restoration of Excess Loss Accounts Due to Worthlessness
The final regulations provide an additional restoration provision
related to S's worthlessness. Under the additional rule, P's excess
loss account with respect to S's stock is restored if any member takes
into account a deduction or loss for the uncollectibility of debt of S
and S does not take into account a corresponding amount of income or
gain in determining consolidated taxable income.
c. Loss Disallowance
The final regulations make technical changes in Sec. 1.1502-20.
Most of these changes conform the rules to the revised investment
adjustment system. For example, the final regulations remove
Sec. 1.1502-20(e)(3) Example 8 because it is no longer necessary under
the revised investment adjustment system. The final regulations also
remove Sec. 1.1502-20(a)(5) Example 6(iii) because it incorrectly
interprets Sec. 1.267(f)-2T. Consideration will be given to relief
under section 7805(b) for taxpayers adversely affected by the changes.
Commentators expressed concern that the statement of purposes set
forth in the proposed investment adjustment rules had the effect of
disallowing positive investment adjustments for S's built-in gains, so
that its stock would be sold at an increased gain. The statement of
purposes was not intended to have this effect and has been modified in
the final regulations.
d. Amendments to the Basis Reduction Account
The current regulations originally provided that, if S became a
nonmember but P continued to own S stock, P's basis in the stock would
be reduced before S became a nonmember. This rule was intended to
eliminate the dividend stripping potential created because P's basis in
S's stock increases for S's E&P during consolidated return years but
generally does not decrease for S's distributions to P after S becomes
a nonmember.
Temporary consolidated return regulations were issued in 1988 to
eliminate this adjustment. Under the temporary regulations, P's basis
increases are not eliminated. Instead, P has a basis reduction account
(BRA) in S's stock and reduces its basis in the stock to the extent P
subsequently receives distributions from S not in excess of the BRA.
The final regulations replace this system with a simpler approach.
However, the BRA continues to apply (together with the other
consequences of S becoming a nonmember) if S becomes a nonmember before
the final regulations are effective.
Commentators requested modifications to the BRA to eliminate
anomalies. The proposed regulations did not modify the BRA because the
approach of the proposed regulations to potential dividend stripping is
inconsistent with the approach of the BRA, and the necessary
corrections would have been complex and may have required amended
returns for prior periods. For the same reasons, the final regulations
do not amend the BRA rules for subsidiaries that ceased to be members
before the final regulations are effective.
e. Becoming or Ceasing To Be a Member
Under the proposed regulations, if S becomes or ceases to be a
member during the group's tax year, the periods ending and beginning
with S's becoming or ceasing to be a member are separate tax years for
all Federal income tax purposes. However, the proposed regulations
provide an election for allocating S's nonextraordinary items of
income, gain, deduction, loss, and credit between the group's year and
S's separate return year. For this purpose, the proposed regulations
identify extraordinary items that are not subject to this ratable
allocation.
The final regulations continue the approach of the proposed
regulations and, in response to comments, the list of extraordinary
items not subject to the ratable allocation election is expanded. In
response to comments, the final regulations also allow S's
nonextraordinary items from the month that S becomes or ceases to be a
member to be allocated ratably within the month.
The proposed regulations provide that S generally becomes a member
or ceases to be a member at the end of the day on which its status as a
member changes (rather than at a specific time during the day). In
response to comments, the final regulations provide that transactions
occurring on the day of the change, but after the event that results in
the change, are treated as occurring at the beginning of the following
day if they are properly allocable to the part of the day after the
event.
f. Distributions
Under Sec. 1.1502-14 of the current regulations, P recognizes no
gain with respect to a distribution from S that is described in section
301(c)(3); instead, such a distribution contributes to an excess loss
account in S's stock. The proposed intercompany transaction regulations
fully address the treatment of these distributions and continue the
treatment provided under current law. See CO-11-91, 59 FR 18011.
Consequently, the proposed amendment to Sec. 1.1502-80 providing for
the nonapplicability of section 301(c)(3) is unnecessary and is not
retained in these final regulations. The treatment under current law is
therefore retained.
The final regulations also clarify that the negative stock basis
adjustment for distributions applies to all amounts to which section
301 applies and all other amounts treated as dividends (e.g., under
section 356(a)(2)).
13. Effective Dates
a. Disposition Approach
The final regulations generally apply to determinations and
transactions in tax years beginning on or after January 1, 1995. Once
the final regulations apply, stock basis and E&P are determined or
redetermined as if the regulations had always been in effect. However,
the final regulations are not taken into account for tax years
beginning before January 1, 1995.
Among the reasons for adopting the disposition approach are: (i) it
eliminates the need to perpetuate prior regulations to determine prior
period adjustments (including the need for E&P studies required to make
the determinations); (ii) it eliminates the need for transitional rules
to prevent duplication or omission of items under the pre-1966,
current, and final regulations; (iii) it incorporates the principles of
section 1503(e)(1)(A), which would otherwise require stock basis
modifications for periods since 1972; and (iv) it eliminates anomalies
arising from the adoption in 1966 of the first complete stock basis
adjustment system (e.g., the inability to reflect pre-1966 E&P in stock
basis if the E&P is lost before a deemed dividend election).
The most frequently discussed alternative to the disposition
approach is a ``lock-in'' approach, under which the new rules would
apply only to adjustments arising after the effective date of the final
regulations. Several commentators suggested using a lock-in approach,
or a combination of approaches (e.g., permitting a group to apply the
current rules for adjustments in prior years, provided S is sold within
the next 3 to 5 years). Commentators cited concerns with the
administrative burdens of recomputing prior period adjustments,
preserving taxpayer expectations, and determining pre-1966 adjustments.
Many taxpayers will benefit from the elimination of anomalies under
the new regulations, and some commentators requested an earlier
effective date, at least on an elective basis (e.g., for determinations
between the date the regulations were proposed and the date they are
finalized).
Although a lock-in approach would avoid requiring groups to apply
the new rules to prior period adjustments, and may protect taxpayer
expectations, the IRS and the Treasury Department understand that few
groups determine their stock basis adjustments annually and therefore
have any substantial expectation regarding stock basis before a stock
disposition is contemplated. A lock-in approach cannot be applied
without complex rules to prevent the duplication or omission of items
that would result from inconsistencies between the current and proposed
regulations. The lock-in approach is therefore inconsistent with the
simplified general approach of the regulations. The final regulations
retain the disposition approach of the proposed regulations.
The proposed regulations would have applied to basis determinations
after the date of adoption of the final regulations. To give taxpayers
advance notice of the final rules, and to avoid complexities from
applying both the current and the final regulations in a single tax
year, the final regulations apply to determinations in tax years
beginning on or after January 1, 1995. For prior years for which
information is incomplete (e.g., pre-1966 years), taxpayers should use
reasonable methods to comply with the final regulations, based on
available information, including income tax returns, financial
statements and statements of retained earnings.
b. Elimination of the 30-day Rules
The proposed regulations, together with Notice 92-59, would have
eliminated the 30-day rules effective February 15, 1993. In response to
comments, the final regulations eliminate the 30-day rules for
subsidiaries that become or cease to be members on or after January 1,
1995.
14. Commissioner's Permission To Deconsolidate
The current regulations generally authorize the Commissioner to
grant all groups, or groups in a particular class, permission to
discontinue filing consolidated returns if any provision of the Code or
regulations has been amended and the amendment could have a substantial
adverse effect.
Some commentators suggested that the proposed regulations warranted
granting permission to deconsolidate because the effective date of the
regulations is based on a disposition approach. Although permission to
deconsolidate is rarely granted, guidance is anticipated to be issued
on or before December 31, 1994, pursuant to which groups may receive
permission to deconsolidate for their first taxable year beginning on
or after January 1, 1995. Permission for a group to deconsolidate will
only be granted, however, on a showing that the net effect of the final
regulations on the group's consolidated tax liability is substantially
adverse.
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)
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.
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
removing the entries for sections ``1.1502-19'', ``1.1502-32(k)'',
``1.1502-32T'', and ``1.1502-80'' and adding the following citations to
read as follows:
Authority: 26 U.S.C. 7805 * * * Section 1.1502-11 also issued
under 26 U.S.C. 1502. * * * Section 1.1502-19 also issued under 26
U.S.C. 301, 1502, and 1503. * * * Section 1.1502-31 also issued
under 26 U.S.C. 1502. * * * Section 1.1502-32 also issued under 26
U.S.C. 301, 1502, and 1503. Section 1.1502-33 also issued under 26
U.S.C. 301, 1502, and 1503. * * * Section 1.1502-76 also issued
under 26 U.S.C. 1502. * * * Section 1.1502-80 also issued under 26
U.S.C. 165, 304, and 1502. * * *
Par. 2. In the list below, for each location indicated in the left
column, remove the language in the middle column, and add the language
in the right column in its place.
----------------------------------------------------------------------------------------------------------------
Affected section Remove Add
----------------------------------------------------------------------------------------------------------------
1.167(c)-1(a)(5)...................... ``and 1.1502-31''.................... ``, 1.1502-13, and 1.1502-14''
1.337(d)-1(a)(5) introductory text.... ``Secs. 1.1502-32 and 1.1502-33(c)''. ``Sec. 1.1502-32''
1.337(d)-2(c)(4) Example.............. Secs. 1.1502-32 and 1.1502-33(c)''... ``Sec. 1.1502-32''
1.469-1T(h)(7)........................ ``1.1502-19(a)''..................... ``1.1502-19''
1.1502-13(j) introductory text........ ``, 1.1502-31,''..................... .................................
1.1502-13(l)(2), Example (1)(i)....... ``under Sec. 1.1502-31(a)''.......... .................................
1.1502-13(m)(3), Example (3)(i)....... ``Under Sec. 1.1502-31(a),''......... .................................
1.1502-13(o)(1)(i).................... ``1.1502-19(b)(2)''.................. ``1.1502-19(c)(1) (ii) or (iii)''
1.1502-13(o)(1)(ii)................... ``1.1502-19(b)(2)''.................. ``1.1502-19(c)(1) (ii) or (iii)''
1.1502-13(o)(2), Example (i).......... ``under Sec. 1.1502-31(a)''.......... .................................
1.1502-13(o)(2), Example (iii)........ ``1.1502-19(b)(2)(i)''............... ``1.1502-19''
1.1502-14(b)(3)(ii)................... ``1.1502-19(b)(2) (other than ``1.1502-19(c)(1)(ii)(B) or
subdivision (ii) thereof)''. (iii)''
1.1502-14(d)(3)(ii)................... ``1.1502-19(b)(2) (other than ``1.1502-19(c)(1)(ii)(B) or
subdivision (ii) thereof)''. (iii)''
1.1502-14(d)(4)(ii)(b)................ ``1.1502-19(b)(2) (other than ``1.1502-19(c)(1)(ii)(B) or
subdivision (ii) thereof), (iii)''
determined without regard to Sec.
1.1502-19(d) and (e)''.
1.1502-14(g)(1)(i).................... ``1.1502-19(b)(2)''.................. ``1.1502-19(c)(1) (ii) or (iii)''
1.1502-14(g)(1)(ii)................... ``1.1502-19(b)(2)''.................. ``1.1502-19(c)(1) (ii) or (iii)''
1.1502-14(g)(2), Example 1(ii)........ ``1.1502-19(b)(2)(i)''............... ``1.1502-19''
1.1502-43(a)(3)(ii)................... ``1.1502-33(c)(4)(ii)''.............. ``1.1502-33(b)''
1.1502-43(a)(3)(iii).................. ``1.1502-33(c)(4)(i)(b)''............ ``1.1502-33(c)(1)''
1.1502-47(e)(4)(iii)(B)............... ``1.1502-19(b)(2)(vi)''.............. ``1.1502-19(c)''
1.1502-75(d)(5)(viii)................. ``1.1502-32(b)(2)(iii)(c) and ``1.1502-32(h)(5)''
(c)(2)(iii)''.
1.1502-81T(a)......................... ``1.1502-32(b)(1)''.................. ``1.1502-32(b)''
1.1552-1(c)(2)........................ ``paragraph (d)(3) of''.............. .................................
----------------------------------------------------------------------------------------------------------------
Par. 3. Section 1.279-6 is amended by revising paragraph (b)(4) to
read as follows:
Sec. 1.279-6 Application of section 279 to certain affiliated groups.
* * * * *
(b) * * *
(4) The basis of property in a transaction to which Sec. 1.1502-13,
Sec. 1.1502-13T, Sec. 1.1502-14, or Sec. 1.1502-14T applies is the
basis of the property determined under that section; and
* * * * *
Par. 4. Section 1.337(d)-1, paragraph (a)(5) is amended by removing
paragraph (iii) of Example 8.
Par. 5. Section 1.1502-1 is amended by adding at the end of
paragraph (a) a new sentence to read as follows:
Sec. 1.1502-1 Definitions.
(a) * * * Except as the context otherwise requires, references to a
group are references to a consolidated group (as defined in paragraph
(h) of this section).
* * * * *
Par. 6. Section 1.1502-11 is amended by revising paragraph (b) to
read as follows:
Sec. 1.1502-11 Consolidated taxable income.
* * * * *
(b) Elimination of circular stock basis adjustments--(1) In
general. If one member (P) disposes of the stock of another member (S),
this paragraph (b) limits the use of S's deductions and losses in the
year of disposition and the carryback of items to prior years. The
purpose of the limitation is to prevent P's income or gain from the
disposition of S's stock from increasing the absorption of S's
deductions and losses, because the increased absorption would reduce
P's basis (or increase its excess loss account) in S's stock under
Sec. 1.1502-32 and, in turn, increase P's income or gain. See paragraph
(b)(3) of this section for the application of these principles to P's
deduction or loss from the disposition of S's stock, and paragraph
(b)(4) of this section for the application of these principles to
multiple stock dispositions. See Sec. 1.1502-19(c) for the definition
of disposition.
(2) Limitation on deductions and losses--(i) Determination of
amount of limitation. If P disposes of one or more shares of S's stock,
the extent to which S's deductions and losses for the tax year of the
disposition (and its deductions and losses carried over from prior
years) may offset income and gain is subject to limitation. The amount
of S's deductions and losses that may offset income and gain is
determined by tentatively computing taxable income (or loss) for the
year of disposition (and any prior years to which the deductions or
losses may be carried) without taking into account P's income and gain
from the disposition.
(ii) Application of limitation. S's deductions and losses offset
income and gain only to the extent of the amount determined under
paragraph (b)(2)(i) of this section. To the extent S's deductions and
losses in the year of disposition cannot offset income or gain because
of the limitation under this paragraph (b), the items are carried to
other years under the applicable provisions of the Internal Revenue
Code and regulations as if they were the only items incurred by S in
the year of disposition. For example, to the extent S incurs an
operating loss in the year of disposition that is limited, the loss is
treated as a separate net operating loss attributable to S arising in
that year. The tentative computation does not affect the manner in
which S's unlimited deductions and losses are absorbed or the manner in
which deductions and losses of other members are absorbed. (If the
amount of S's unlimited deductions and losses actually absorbed is less
than the amount absorbed in the tentative computation, P's stock basis
adjustments under Sec. 1.1502-32 reflect only the amounts actually
absorbed.)
(iii) Examples. For purposes of the examples in this paragraph (b),
unless otherwise stated, P owns all of the only class of S's stock for
the entire year, S owns no stock of lower-tier members, the tax year of
all persons is the calendar year, all persons use the accrual method of
accounting, the facts set forth the only corporate activity, all
transactions are between unrelated persons, and tax liabilities are
disregarded. The principles of this paragraph (b)(2) are illustrated by
the following examples.
Example 1. Limitation on losses with respect to stock gain. (a)
P has a $500 basis in S's stock. For Year 1, P has ordinary income
of $30 (determined without taking P's gain or loss from the
disposition of S's stock into account) and S has an $80 ordinary
loss. P sells S's stock for $520 at the close of Year 1.
(b) To determine the amount of the limitation on S's loss under
paragraph (b)(2)(i) of this section, and the effect under
Sec. 1.1502-32(b) of the absorption of S's loss on P's basis in S's
stock, P's gain or loss from the disposition of S's stock is not
taken into account. The group is tentatively treated as having a
consolidated net operating loss of $50 (P's $30 of income minus S's
$80 loss). Thus, $50 of S's loss is limited under this paragraph
(b).
(c) Because $30 of S's loss is absorbed in the determination of
consolidated taxable income under paragraph (b)(2)(ii) of this
section, P's basis in S's stock is reduced under Sec. 1.1502-32(b)
from $500 to $470 immediately before the disposition. Consequently,
P recognizes a $50 gain from the sale of S's stock and the group has
consolidated taxable income of $50 for Year 1 (P's $30 of ordinary
income and $50 gain from the sale of S's stock, less the $30 of S's
loss). In addition, S's limited loss of $50 is treated as a separate
net operating loss attributable to S and, because S ceases to be a
member, the loss is apportioned to S under Sec. 1.1502-79 and
carried to its first separate return year.
Example 2. Carrybacks and carryovers. (a) For Year 1, the P
group has consolidated taxable income of $30, and a consolidated net
capital loss of $100 ($50 attributable to P and $50 to S). At the
beginning of Year 2, P has a $300 basis in S's stock. For Year 2, P
has ordinary income of $30, and a $20 capital gain (determined
without taking the $100 consolidated net capital loss carryover or
P's gain or loss from the disposition of S's stock into account),
and S has a $100 ordinary loss. P sells S's stock for $280 at the
close of Year 2.
(b) To determine the amount of the limitation under paragraph
(b)(2)(i) of this section on S's losses, and the effect of the
absorption of S's losses on P's basis in S's stock under
Sec. 1.1502-32(b), P's gain or loss from the disposition of S's
stock is not taken into account. For Year 2, the P group is
tentatively treated as having a $70 consolidated net operating loss
(S's $100 ordinary loss, less P's $30 of ordinary income). The P
group is also treated as having no consolidated net capital gain in
Year 2, because P's $20 capital gain is reduced by $20 of the
consolidated net capital loss carryover from Year 1 under section
1212(a) (the absorption of which is attributed equally to P and S).
In addition, of the $70 consolidated net operating loss, $30 is
carried back to Year 1 and offsets P's ordinary income in that year,
and $40 is carried forward. Consequently, $40 of S's operating loss
from Year 2, and $40 of the consolidated net capital loss carryover
from Year 1 attributable to S, are limited under this paragraph (b).
(c) Under paragraph (b)(2)(ii) of this section, the limitation
under this paragraph (b) does not affect the absorption of any
deductions and losses attributable to P, $60 of S's operating loss
from Year 2, and $10 of the consolidated net capital loss from Year
1 attributable to S. Consequently, P's basis in S's stock is reduced
under Sec. 1.1502-32(b) by $70, from $300 to $230, and P recognizes
a $50 gain from the sale of S's stock in Year 2. Thus, the P group
is treated as having a $20 unlimited net operating loss that is
carried back to Year 1:
Ordinary income:
P........................................................... $30
S (excluding the $40 limited loss).......................... (60)
---------
Sub Total................................................. $(30)
Consolidated net capital gain:
P ($20 + $50 from S stock - $50 from Year 1)................ $20
S (-$10 from Year 1)........................................ (10)
---------
Sub Total................................................. $10
Consolidated taxable income................................... $(20)
(d) Under paragraph (b)(2)(ii) of this section, S's $40 ordinary
loss from Year 2 that is limited under this paragraph (b) is treated
as a separate net operating loss arising in Year 2. Similarly, $40
of the consolidated net capital loss from Year 1 attributable to S
is treated as a separate net capital loss carried over from Year 1.
Because S ceases to be a member, the $40 net operating loss from
Year 2 and the $40 consolidated net capital loss from Year 1 are
allocated to S under Sec. 1.1502-79 and are carried to S's first
separate return year.
Example 3. Allocation of basis adjustments. (a) For Year 1, the
P group has consolidated taxable income of $100. At the beginning of
Year 2, P has a $40 basis in each of the 10 shares of S's stock. For
Year 2, P has an $80 ordinary loss (determined without taking into
account P's gain or loss from the disposition of S's stock) and S
has an $80 ordinary loss. P sells 2 shares of S's stock for $85 each
at the close of Year 2.
(b) Under paragraph (b)(2)(i) of this section, the amount of the
limitation on S's loss is determined by tentatively treating the P
group as having a $160 consolidated net operating loss for Year 2.
Of this amount, $100 is carried back under section 172 and absorbed
in Year 1 ($50 attributable to S and $50 attributable to P).
Consequently, $30 of S's loss is limited under this paragraph (b).
(c) Under paragraph (b)(2)(ii) of this section, the limitation
under this paragraph (b) does not affect the absorption of P's $80
ordinary loss or $50 of S's ordinary loss. Consequently, P's basis
in each share of S's stock is reduced from $40 to $35 under
Sec. 1.1502-32(b), and P recognizes a $100 gain from the sale of the
2 shares. Thus, the P group is treated as having a $30 unlimited net
operating loss:
Ordinary loss:
P........................................................... $(80)
S (excluding the $30 limited loss).......................... (50)
---------
Sub Total................................................. $(130)
Consolidated net capital gain:
P........................................................... $100
S........................................................... 0
---------
Sub Total................................................. $100
Unlimited consolidated net operating loss..................... $(30)
(d) A portion of the $130 of unlimited operating losses for Year
2 is fully absorbed in that year, and a portion is carried back to
Year 1. Thus, $61.50 of P's $80 loss ($100 multiplied by $80/$130)
and $38.50 of S's $50 unlimited loss ($100 multiplied by $50/$130)
are absorbed in Year 2. P's remaining $18.50 of loss and S's
remaining $11.50 of loss are not subject to limitation and are
carried back and absorbed in Year 1.
(e) Under paragraph (b)(2)(ii) of this section, S's $30 of loss
limited under this paragraph (b) is treated as a separate net
operating loss and, because S ceases to be a member, the loss is
apportioned to S under Sec. 1.1502-79 and carried to its first
separate return year.
(3) Loss dispositions--(i) General rule. The principles of
paragraph (b)(2) of this section apply to the extent necessary to
carry out the purposes of paragraph (b)(1) of this section if P
recognizes a deduction or loss from the disposition of S's stock.
(ii) Example. The principles of this paragraph (b)(3) are
illustrated by the following example.
Example. (a) P has a $400 basis in S's stock. For Year 1, P has
a capital gain of $100 (determined without taking P's gain or loss
from the disposition of S's stock into account) and S has both a $60
capital loss and a $200 ordinary loss. P sells S's stock for $140 at
the close of Year 1.
(b) Under paragraph (b)(3) of this section, the amount of S's
ordinary and capital losses that may offset income and gain is
determined by tentatively computing the group's consolidated net
operating loss and consolidated net capital loss without taking into
account P's loss from the disposition of S's stock. The limitation
is necessary to prevent P's loss from the disposition of S's stock
from affecting the absorption of S's losses and thereby the
adjustments to P's basis in S's stock under Sec. 1.1502-32(b) (which
would, in turn, affect P's loss).
(c) Under the principles of paragraph (b)(2)(i) of this section,
the amount of the limitation on S's loss is determined by
tentatively treating the P group as having a $40 consolidated net
capital gain and a $200 ordinary loss, which results in a $160
consolidated net operating loss for Year 1, all of which is
attributable to S. Thus, $160 of S's ordinary loss is limited under
this paragraph (b). See also Sec. 1.1502-20 for rules applicable to
losses from the sale of stock of subsidiaries.
(4) Multiple dispositions--(i) Stock of a member. To the extent
income, gain, deduction, or loss from a prior disposition of S's stock
is deferred under any rule of law, the limitation under paragraph
(b)(2) of this section is determined by treating the year the deferred
amount is taken into account as the year of the disposition.
(ii) Stock of different members. If S is a higher-tier corporation
with respect to another member (T), and all of T's items of income,
gain, deduction, and loss (including the absorption of T's deduction or
loss) would be fully reflected in P's basis in S's stock under
Sec. 1.1502-32, the limitation under paragraph (b)(2)(i) of this
section with respect to T's deductions and losses is determined without
taking into account any income, gain, deduction, or loss from the
disposition of the stock of S or T (or of the stock of members owned in
the chain connecting S and T). However, this paragraph (b) does not
otherwise limit the absorption of one member's deduction or loss with
respect to the disposition of another member's stock.
(iii) Examples. The principles of this paragraph (b)(4) are
illustrated by the following examples.
Example 1. Chain of subsidiaries. (a) P owns all of S's stock
with a $500 basis, and S owns all of T's stock with a $500 basis.
For Year 1, P has ordinary income of $30, S has no income or loss,
and T has an $80 ordinary loss. P sells S's stock for $520 at the
close of Year 1.
(b) Under paragraph (b)(4) of this section, to determine the
amount of the limitation under paragraph (b) of this section on T's
loss, and the effect of the absorption of T's loss on P's basis in
S's stock under Sec. 1.1502-32(b), P's gain or loss from the
disposition of S's stock is not taken into account. The group is
tentatively treated as having a consolidated net operating loss of
$50 (P's $30 of income minus T's $80 loss). Because only $30 of T's
loss offsets income or gain, P's basis in S's stock is reduced under
Sec. 1.1502-32(b) from $500 to $470 immediately before the
disposition of S's stock. Thus, P takes into account a $50 gain from
the sale of S's stock.
(c) The facts are the same as in paragraph (a) of this Example
1, except that S has a $10 excess loss account in T's stock (rather
than a $500 basis). Under paragraph (b)(4) of this section, neither
P's gain or loss from the disposition of S's stock nor S's gain or
loss from the disposition of T's stock (under Sec. 1.1502-19) are
taken into account for purposes of the tentative computations and
the effect of any absorption under Sec. 1.1502-32(b) on P's basis in
S's stock and S's excess loss account in T's stock. The group is
tentatively treated as having a consolidated net operating loss of
$50 (P's $30 of income minus T's $80 loss), and only $30 of T's loss
may offset the group's income or gain. Under Sec. 1.1502-32(b), the
absorption of $30 of T's loss increases S's excess loss account in
T's stock to $40 and, under Sec. 1.1502-19, the excess loss account
is taken into account. Moreover, under Sec. 1.1502-32(b), P's basis
in S's stock is increased immediately before the sale by $10 (S's
$40 gain under Sec. 1.1502-19(b) minus T's $30 loss absorbed and
tiered up under Sec. 1.1502-32(b)), from $500 to $510. Thus, P takes
into account a $10 gain from the sale of S's stock, and S takes into
account a $40 gain from its excess loss account in T's stock.
Example 2. Brother-sister subsidiaries. (a) P owns all of the
stock of S1 and S2, each with a $50 basis. For Year 1, the group has
a $100 consolidated net operating loss ($50 of which is attributable
to S1, and $50 to S2) determined without taking gain or loss from
the disposition of member stock into account. At the close of Year
1, P sells the stock of S1 and S2 for $100 each.
(b) Paragraph (b)(4) of this section does not limit the loss of
S1 or S2 with respect to the disposition of stock of the other.
Consequently, each subsidiary's loss may offset P's gain from the
disposition of the stock of the other subsidiary. Because this
absorption results in a $50 reduction in P's basis in the stock of
each subsidiary under Sec. 1.1502-32(b), P's aggregate gain from the
stock dispositions is increased from $100 to $200, $100 of which is
offset by the losses of the subsidiaries.
(5) Effective date. This paragraph (b) applies to stock
dispositions occurring in consolidated return years beginning on or
after January 1, 1995. For prior years, see Sec. 1.1502-11(b) as
contained in the 26 CFR part 1 edition revised as of April 1, 1994.
Par. 7. Section 1.1502-13 is amended as follows:
1. In paragraph (c)(1)(iii), the second sentence is removed.
2. Paragraph (c)(7) is redesignated as paragraph (c)(8).
3. New paragraph (c)(7) is added.
4. In paragraph (h), Example (17)(ii) is revised.
5. The added and revised provisions read as follows:
Sec. 1.1502-13 Intercompany transactions.
* * * * *
(c) * * *
(7) Basis. The basis of property acquired by a purchasing member in
a deferred intercompany transaction is determined as if separate
returns were filed. For example, if S owns property with an adjusted
basis of $80 and sells it to P for $100 in a deferred intercompany
transaction, P's basis in the property is $100 even though S defers its
$20 gain on the sale under this paragraph (c).
* * * * *
(h) * * *
Example (17). * * *
(ii) P takes the entire $44,000 gain ($104,000 less $60,000) on
the land into account for 1966 since the deferral and basis rules
provided in paragraph (c) of this section were not effective with
respect to the sale of such land.
* * * * *
Par. 8. Section 1.1502-14 is amended as follows:
1. Paragraph (a)(2) is revised.
2. Paragraph (a)(4) is redesignated as paragraph (a)(6).
3. New paragraph (a)(4) is added.
4. Paragraph (a)(5) is revised.
5. In newly designated paragraph (a)(6), the Example is amended by
revising the last sentence.
6. New paragraph (b)(4) is added.
7. The revised and added provisions read as follows:
Sec. 1.1502-14 Stock, bonds, and other obligations of members.
(a) * * *
(2) Nondividend distributions. No gain is recognized to the
distributee on a distribution with respect to stock, from one member to
another member during a consolidated return year, which is described in
section 301(c) (2) or (3). See Secs. 1.1502-19 and 1.1502-32 for
adjustments to stock basis (including negative adjustments in excess of
basis).
* * * * *
(4) Basis of property distributed in kind. The basis of property
received in a distribution to which section 301 applies is determined
under section 301(d)(2)(B).
(5) Entitlement rule--(i) In general. This paragraph (a)(5)(i)
applies for consolidated return years beginning on or after January 1,
1995. For all Federal income tax purposes, a distribution to which this
paragraph (a) applies is treated as taken into account when the
shareholding member becomes entitled to it (generally on the record
date). For example, if the distributee member becomes entitled to a
cash distribution before it is made, the distribution is treated as
made when the distributee member becomes entitled to it. For this
purpose, stock is treated as entitled to a distribution no later than
the time the distribution is taken into account under the Code (e.g.,
under section 305). Appropriate adjustments must be made, as of the
date the distribution was taken into account, if a distribution is not
made.
(ii) Minority shareholders. If nonmembers own stock of the
distributing corporation at the time the distribution is treated as
occurring under paragraph (a)(5)(i) of this section, appropriate
adjustments must be made to prevent acceleration of the members'
portion of the distribution from affecting the earnings and profits
consequences of distributions to nonmembers.
(iii) Prior period distributions. For rules relating to
distributions before paragraph (a)(5)(i) of this section applies, see
Secs. 1.1502-14(a) (intercompany distributions generally) and 1.1502-
32(k) (distributions declared before, but paid after, a stock
disposition) as contained in the 26 CFR part 1 edition revised as of
April 1, 1994.
(6) * * *
Example. * * * P's basis in the land is $6,000.
* * * * *
(b) * * *
(4) Basis after liquidation or distribution. The basis of property
acquired in a transaction to which this paragraph (b) applies is
determined as follows:
(i) Section 332. The basis of property acquired in a liquidation to
which section 332 applies is determined as if separate returns were
filed.
(ii) Other liquidations and distributions. This paragraph
(b)(4)(ii) determines the aggregate basis of all property acquired in a
distribution in cancellation or redemption of stock to which paragraph
(b)(1) of this section applies, other than a liquidation to which
section 332 applies. Once the amount of aggregate basis is determined,
it is allocated among the assets received (except cash) in proportion
to the fair market values of the assets on the date received. The
aggregate amount of basis equals--
(A) The adjusted basis of the stock exchanged therefor (determined
after taking into account the adjustments under Sec. 1.1502-32);
increased by
(B) The amount of any liabilities of the distributing corporation
assumed by the distributee or to which the property acquired is
subject; reduced by
(C) The amount of cash received in the distribution.
* * * * *
Par. 9. Section 1.1502-19 is revised to read as follows:
Sec. 1.1502-19 Excess loss accounts.
(a) In general--(1) Purpose. This section provides rules for a
member (P) to include in income its excess loss account in the stock of
another member (S). The purpose of the excess loss account is to
recapture in consolidated taxable income P's negative adjustments with
respect to S's stock (e.g., under Sec. 1.1502-32 from S's deductions,
losses, and distributions), to the extent the negative adjustments
exceed P's basis in the stock.
(2) Excess loss accounts--(i) In general. P's basis in S's stock is
adjusted under the consolidated return regulations and other rules of
law. Negative adjustments may exceed P's basis in S's stock. The
resulting negative amount is P's excess loss account in S's stock. For
example:
(A) Once P's negative adjustments under Sec. 1.1502-32 exceed its
basis in S's stock, the excess is P's excess loss account in the S
stock. If P has further adjustments, they first increase or decrease
the excess loss account.
(B) If P forms S by transferring property subject to liabilities in
excess of basis, Sec. 1.1502-80(d) provides for the nonapplicability of
section 357(c) and the resulting negative basis under section 358 is
P's excess loss account in the S stock.
(ii) Treatment as negative basis. P's excess loss account is
treated for all Federal income tax purposes as basis that is a negative
amount, and a reference to P's basis in S's stock includes a reference
to P's excess loss account.
(3) Application of other rules of law. The rules of this section
are in addition to other rules of law. See, e.g., Secs. 1.1502-32
(investment adjustment rules establishing and adjusting excess loss
accounts) and 1.1502-80(d) (nonapplicability of section 357(c)). The
provisions of this section and other rules of law must not be applied
to recapture the same amount more than once. For purposes of this
section, the definitions in Sec. 1.1502-32 apply.
(b) Excess loss account taken into account as income or gain--(1)
General rule. If P is treated under this section as disposing of a
share of S's stock, P takes into account its excess loss account in the
share as income or gain from the disposition. Except as provided in
paragraph (b)(4) of this section, the disposition is treated as a sale
or exchange for purposes of determining the character of the income or
gain.
(2) Nonrecognition or deferral--(i) In general. P's income or gain
under paragraph (b)(1) of this section is subject to any nonrecognition
or deferral rules applicable to the disposition. For example, if S
liquidates and the exchange of P's stock in S is subject to section
332, or P transfers all of its assets (including S's stock) to S in a
reorganization to which section 361(a) applies, P's income or gain from
the excess loss account is not recognized under these rules.
(ii) Nonrecognition or deferral inapplicable. If P's income or gain
under paragraph (b)(1) of this section is from a disposition described
in paragraph (c)(1) (ii) or (iii) of this section (relating to
deconsolidations and worthlessness), the income or gain is taken into
account notwithstanding any nonrecognition or deferral rules (even if
the disposition is also described in paragraph (c)(1)(i) of this
section). For example, if P transfers S's stock to a nonmember in a
transaction to which section 351 applies, P's income or gain from the
excess loss account is taken into account.
(3) Tiering up in chains. If the stock of more than one subsidiary
is disposed of in the same transaction, the income or gain under this
section is taken into account in the order of the tiers, from the
lowest to the highest.
(4) Insolvency--(i) In general. Gain under this section is treated
as ordinary income to the extent of the amount by which S is insolvent
(within the meaning of section 108(d)(3)) immediately before the
disposition. For this purpose S's liabilities include any amount to
which preferred stock would be entitled if S were liquidated
immediately before the disposition, and any former liabilities that
were discharged to the extent the discharge was treated as tax-exempt
income under Sec. 1.1502-32(b)(3)(ii)(C) (special rule for discharges).
(ii) Reduction for amount of distributions. The amount treated as
ordinary income under this paragraph (b)(4) is reduced to the extent it
exceeds the amount of P's excess loss account redetermined without
taking into account S's distributions to P to which Sec. 1.1502-
32(b)(2)(iv) applies.
(c) Disposition of stock. For purposes of this section:
(1) In general. P is treated as disposing of a share of S's stock:
(i) Transfer, cancellation, etc. At the time--
(A) P transfers or otherwise ceases to own the share for Federal
income tax purposes, even if no gain or loss is taken into account; or
(B) P takes into account gain or loss (in whole or in part) with
respect to the share.
(ii) Deconsolidation. At the time--
(A) P becomes a nonmember, or a nonmember determines its basis in
the share (or any other asset) by reference to P's basis in the share,
directly or indirectly, in whole or in part (e.g., under section 362);
or
(B) S becomes a nonmember, or P's basis in the share is reflected,
directly or indirectly, in whole or in part, in the basis of any asset
other than member stock (e.g., under section 1071).
(iii) Worthlessness. At the time--
(A) Substantially all of S's assets are treated as disposed of,
abandoned, or destroyed for Federal income tax purposes (e.g., under
section 165(a) or Sec. 1.1502-80(c), or, if S's asset is stock of a
lower-tier member, the stock is treated as disposed of under this
paragraph (c)). An asset of S is not considered to be disposed of or
abandoned to the extent the disposition is in complete liquidation of S
or is in exchange for consideration;
(B) An indebtedness of S is discharged, if any part of the amount
discharged is not included in gross income and is not treated as tax-
exempt income under Sec. 1.1502-32(b)(3)(ii)(C); or
(C) A member takes into account a deduction or loss for the
uncollectibility of an indebtedness of S, and the deduction or loss is
not matched in the same tax year by S's taking into account a
corresponding amount of income or gain from the indebtedness in
determining consolidated taxable income.
(2) Becoming a nonmember. A member is treated as becoming a
nonmember if it has a separate return year (including another group's
consolidated return year). For example, S may become a nonmember if it
issues additional stock to nonmembers, but S does not become a
nonmember as a result of its complete liquidation. A disposition under
paragraph (c)(1)(ii) of this section must be taken into account in the
consolidated return of the group. For example, if a group ceases under
Sec. 1.1502-75(c) to file a consolidated return as of the close of its
consolidated return year, the disposition under paragraph (c)(1)(ii) of
this section is treated as occurring immediately before the close of
the year. If S becomes a nonmember because P sells S's stock to a
nonmember, P's sale is a disposition under both paragraphs (c)(1) (i)
and (ii) of this section. If a group terminates under Sec. 1.1502-75(d)
because the common parent is the only remaining member, the common
parent is not treated as having a deconsolidation event under paragraph
(c)(1)(ii) of this section.
(3) Exception for acquisition of group--(i) Application. This
paragraph (c)(3) applies only if a consolidated group (the terminating
group) ceases to exist as a result of--
(A) The acquisition by a member of another consolidated group of
either the assets of the common parent of the terminating group in a
reorganization described in section 381(a)(2), or the stock of the
common parent of the terminating group; or
(B) The application of the principles of Sec. 1.1502-75(d)(2) or
(d)(3).
(ii) General rule. Paragraph (c)(1)(ii) of this section does not
apply solely by reason of the termination of a group in a transaction
to which this paragraph (c)(3) applies, if there is a surviving group
that is, immediately thereafter, a consolidated group. Instead, the
surviving group is treated as the terminating group for purposes of
applying this section to the terminating group. This treatment does not
apply, however, to members of the terminating group that are not
members of the surviving group immediately after the terminating group
ceases to exist (e.g., under section 1504(a)(3) relating to
reconsolidation, or section 1504(c) relating to includible insurance
companies).
(d) Special allocation of basis adjustments or determinations. If a
member has an excess loss account in shares of a class of S's stock at
the time of a basis adjustment or determination under the Internal
Revenue Code with respect to other shares of the same class of S's
stock owned by the member, the adjustment or determination is allocated
first to equalize and eliminate that member's excess loss account. For
example, if P owns 50 shares of S's only class of stock with a $100
basis and 50 shares with a $100 excess loss account, and P contributes
$200 to S without receiving additional shares, the contribution first
eliminates P's excess loss account, then increases P's basis in each
share by $1. (If P transfers the $200 in exchange for an additional 100
shares of S's stock in a transaction to which section 351 applies, P's
excess loss account is first eliminated, and P's basis in the
additional shares is $100.) See Sec. 1.1502-32(c) for similar
allocations of investment adjustments to prevent or eliminate excess
loss accounts.
(e) Anti-avoidance rule. If any person acts with a principal
purpose contrary to the purposes of this section, to avoid the effect
of the rules of this section or apply the rules of this section to
avoid the effect of any other provision of the consolidated return
regulations, adjustments must be made as necessary to carry out the
purposes of this section.
(f) Predecessors and successors. For purposes of this section, any
reference to a corporation (or to a share of the corporation's stock)
includes a reference to a successor or predecessor (or to a share of
stock of a predecessor or successor), as the context may require.
(g) Examples. For purposes of the examples in this section, unless
otherwise stated, P owns all of the only class of S's stock and S owns
all of the only class of T's stock, the stock is owned for the entire
year, T owns no stock of lower-tier members, the tax year of all
persons is the calendar year, all persons use the accrual method of
accounting, the facts set forth the only corporate activity, all
transactions are between unrelated persons, and tax liabilities are
disregarded. The principles of this section are illustrated by the
following examples.
Example 1. Taxable disposition of stock. (a) Facts. P has a $150
basis in S's stock, and S has a $100 basis in T's stock. For Year 1,
P has $500 of ordinary income, S has no income or loss, and T has a
$200 ordinary loss. S sells T's stock to a nonmember for $60 at the
close of Year 1.
(b) Analysis. Under paragraph (c) of this section, the sale is a
disposition of T's stock at the close of Year 1 (the day of the
sale). Under Sec. 1.1502-32(b), T's loss results in S having a $100
excess loss account in T's stock immediately before the sale. Under
paragraph (b)(1) of this section, S takes into account the $100
excess loss account as an additional $100 of gain from the sale.
Consequently, S takes into account a $160 gain from the sale in
determining the group's consolidated taxable income. Under
Sec. 1.1502-32(b), T's $200 loss and S's $160 gain result in a net
$40 decrease in P's basis in S's stock as of the close of Year 1,
from $150 to $110.
(c) Intercompany sale followed by sale to nonmember. The facts
are the same as in paragraph (a) of this Example 1, except that S
sells T's stock to P for $60 at the close of Year 1, and P sells T's
stock to a nonmember at a gain at the beginning of Year 5. Under
paragraph (c) of this section, S's sale is treated as a disposition
of T's stock at the close of Year 1 (the day of the sale). Under
Sec. 1.1502-13 and paragraph (b)(2) of this section, S's $160 gain
from the sale is deferred and taken into account in Year 5 as a
result of P's sale of the T stock. Under Sec. 1.1502-32(b), the
absorption of T's $200 loss in Year 1 results in P having a $50
excess loss account in S's stock at the close of Year 1. In Year 5,
S's $160 gain taken into account eliminates P's excess loss account
in S's stock and increases P's basis in the stock to $110.
(d) Intercompany distribution followed by sale to a nonmember.
The facts are the same as in paragraph (a) of this Example 1, except
that the value of the T stock is $60 and S declares and distributes
a dividend of all of the T stock to P at the close of Year 1, and P
sells the T stock to a nonmember at a gain at the beginning of Year
5. Under paragraph (c) of this section, S's distribution is treated
as a disposition of T's stock at the close of Year 1 (the day of the
distribution). S's $100 excess loss account in T's stock is treated
as additional gain under section 311(b) from the distribution. Under
Sec. 1.1502-14(a), P's basis in the T stock is $60. Under
Sec. 1.1502-14, Sec. 1.1502-14T, and paragraph (b)(2) of this
section, S's $160 gain from the distribution is deferred and taken
into account in Year 5 as a result of P's sale of the T stock. Under
Sec. 1.1502-32(b), T's $200 loss and S's $60 distribution result in
P having a $110 excess loss account in S's stock at the close of
Year 1. In Year 5, S's $160 gain taken into account eliminates P's
excess loss account in S's stock and increases P's basis in the
stock to $50.
Example 2. Basis determinations under the Internal Revenue Code
in intercompany reorganizations. (a) Facts. P owns all of the stock
of S and T. P has a $150 basis in S's stock and a $100 excess loss
account in T's stock. P transfers T's stock to S without receiving
additional S stock, in a transaction to which section 351 applies.
(b) Analysis. Under paragraph (c) of this section, P's transfer
is treated as a disposition of T's stock. Under section 351 and
paragraph (b)(2) of this section, P does not recognize gain from the
disposition. Under section 358 and paragraph (a)(2)(ii) of this
section, P's $100 excess loss account in T's stock decreases P's
$150 basis in S's stock to $50. In addition, S takes a $100 excess
loss account in T's stock under section 362. (If P had received
additional S stock, paragraph (d) of this section would not apply to
shift basis from P's original S stock because the basis of the
original stock is not adjusted or determined as a result of the
contribution; but paragraph (d) would apply to shift basis if P had
transferred S's stock to T in exchange for additional T stock,
because the basis of the additional T stock would be determined when
P has an excess loss account in its original T stock.)
(c) Intercompany merger. The facts are the same as in paragraph
(a) of this Example 2, except that T merges into S in a
reorganization described in section 368(a)(1)(A) (and in section
368(a)(1)(D)), and P receives no additional S stock in the
reorganization. Under section 354 and paragraph (b)(2) of this
section, P does not recognize gain. Under section 358 and paragraph
(a)(2)(ii) of this section, P's $100 excess loss account in T's
stock decreases P's $150 basis in the S stock to $50. (Similarly, if
S merges into T and P does not receive additional T stock, P's $150
basis in S's stock eliminates P's excess loss account in T's stock,
and increases P's basis in T's stock to $50.)
(d) Liquidation of only subsidiary. Assume instead that P and S
are the only members of the P group, P has a $100 excess loss
account in S's stock, and S liquidates in a transaction to which
section 332 applies. Under paragraph (c)(2) of this section, the
liquidation is not a deconsolidation event under paragraph
(c)(1)(ii) of this section merely because P is the only remaining
member. Under section 332 and paragraph (b)(2) of this section, P
does not recognize gain. Under section 334(b), P succeeds to S's
basis in the assets it receives from S in the liquidation. (P would
also not recognize gain if P transferred all of its assets
(including S's stock) to S in a reorganization to which section
361(a) applied, because S would be a successor to P under paragraph
(f) of this section.)
Example 3. Section 355 distribution of stock with an excess loss
account. (a) Facts. P has a $30 excess loss account in S's stock,
and S has a $90 excess loss account in T's stock. S distributes the
T stock to P in a transaction to which section 355 applies, and
neither P nor S recognizes any gain or loss. At the time of the
distribution, the T stock represents 33% of the value of the S
stock. Following the distribution, P's basis in the S stock is
allocated under Sec. 1.358-2 in proportion to the fair market values
of the S stock and the T stock.
(b) Analysis. Under paragraph (c) of this section, S's
distribution of the T stock is treated as a disposition. Under
section 355(c) and paragraph (b)(2) of this section, S does not
recognize any gain from the distribution. Under section 358, S's
excess loss account in the T stock is eliminated, and P's $30 excess
loss account in the S stock is treated as basis allocated between
the S stock and the T stock based on their relative values.
Consequently, P has a $20 excess loss account in the S stock and a
$10 excess loss account in the T stock. (If P had a $30 basis rather
than a $30 excess loss account in the S stock, S would not recognize
gain, its excess loss account in the T stock would be eliminated,
and P's basis in the stock of S and T would be $20 and $10,
respectively.)
(c) Section 355 distribution to nonmember. The facts are the
same as in paragraph (a) of this Example 3, except that P also
distributes the T stock to its shareholders in a transaction to
which section 355 applies. Under paragraph (c) of this section, P's
distribution is treated as a disposition of T's stock. Under
paragraph (b)(2) of this section, because P's disposition is
described in paragraph (c)(1)(ii) of this section, P's $10 excess
loss account in the T stock must be taken into account at the time
of the distribution, notwithstanding the nonrecognition rules of
section 355(c).
Example 4. Deconsolidation of a member. (a) Facts. P has a $50
excess loss account in S's stock, and S has a $100 excess loss
account in T's stock. T issues additional stock to a nonmember and,
as a consequence, T becomes a nonmember.
(b) Analysis. Under paragraph (c)(2) of this section, S is
treated as disposing of T's stock immediately before T becomes a
nonmember. Under paragraph (b)(1) of this section, S takes into
account its $100 excess loss account as gain from the sale or
exchange of T's stock. Under Sec. 1.1502-32(b) of this section, S's
$100 gain eliminates P's excess loss account in S's stock and
increases P's basis in S's stock to $50.
(c) Deconsolidation of a higher-tier member. The facts are the
same as in paragraph (a) of this Example 4, except that S (rather
than T) issues the stock and, as a consequence, both S and T become
nonmembers. Under paragraph (c)(2) of this section, P is treated as
disposing of S's stock and S is treated as disposing of T's stock
immediately before S and T become nonmembers. Under Sec. 1.1502-
32(b) and paragraph (b)(3) of this section, because S and T become
nonmembers in the same transaction and T is the lower-tier member, S
is first treated under paragraph (b)(1) of this section as taking
into account its $100 excess loss account as gain from the sale or
exchange of T's stock. Under Sec. 1.1502-32(b), S's $100 gain
eliminates P's excess loss account in S's stock and increases P's
basis in S's stock to $50 immediately before S becomes a nonmember.
Thus, only S's $100 gain is taken into account in the determination
of the group's consolidated taxable income.
(d) Intercompany gain and deconsolidation. The facts are the
same as in paragraph (c) of this Example 4, except that T has $30 of
gain that is deferred under Sec. 1.1502-13 and taken into account in
determining consolidated taxable income immediately before T becomes
a nonmember. Under Sec. 1.1502-32(b), T's $30 gain decreases S's
excess loss account in T's stock from $100 to $70 immediately before
S is treated as disposing of T's stock. Under paragraph (b)(1) of
this section, S is treated as taking into account its $70 excess
loss account as gain from the disposition of T's stock. Under
Sec. 1.1502-32(b), S's $70 gain from the excess loss account and T's
$30 deferred gain that is taken into account eliminate P's $50
excess loss account in S's stock and increase P's basis in S's stock
to $50 immediately before S becomes a nonmember.
Example 5. Worthlessness. (a) Facts. P forms S with a $150
contribution, and S borrows $150. For Year 1, S has a $50 ordinary
loss that is carried over as part of the group's consolidated net
operating loss. For Year 2, P has $160 of ordinary income, and S has
a $160 ordinary loss. Under Sec. 1.1502-32(b), S's loss results in P
having a $10 excess loss account in S's stock. During Year 3, the
value of S's assets (without taking S's liabilities into account)
continues to decline and S's stock becomes worthless within the
meaning of section 165(g) (without taking into account Sec. 1.1502-
80(c)). For Year 4, S has $10 of ordinary income.
(b) Analysis. Under paragraph (c)(1)(iii)(A) of this section, P
is not treated as disposing of S's stock in Year 3 solely because
S's stock becomes worthless within the meaning of section 165(g)
(taking S's liabilities into account). In addition, because S's
stock is not treated as worthless, section 382(g)(4)(D) does not
prevent the Year 1 consolidated net operating loss carryover from
offsetting S's $10 of income in Year 4.
(c) Discharge of indebtedness. The facts are the same as in
paragraph (a) of this Example 5, except that, instead of S's stock
becoming worthless within the meaning of section 165(g), S's
creditor discharges $40 of S's indebtedness during Year 3, S is
insolvent by more than $40 before the discharge, the discharge is
excluded from the P group's gross income under section 108(a), and
$40 of the $50 consolidated net operating loss carryover
attributable to S is eliminated under section 108(b). Under
Sec. 1.1502- 32(b)(3)(ii)(C), S's $40 of discharge income is treated
as tax-exempt income because there is a corresponding decrease under
Sec. 1.1502-32(b)(3)(iii) for elimination of the loss carryover.
Under paragraph (c)(1)(iii)(B) of this section, P is treated as
disposing of S's stock if the amount discharged is not included in
gross income and is not treated as tax-exempt income under
Sec. 1.1502-32(b)(3)(ii)(C). Because the discharge is treated as
tax-exempt income, P is not treated as disposing of S's stock by
reason of the discharge.
Example 6. Avoiding worthlessness. (a) Facts. P forms S with a
$100 contribution and S borrows $150. For Years 1 through 5, S has a
$210 ordinary loss that is absorbed by the group. Under Sec. 1.1502-
32(b), S's loss results in P having a $110 excess loss account in
S's stock. S defaults on the indebtedness, but the creditor does not
discharge the debt (or initiate collection procedures). At the
beginning of Year 6, S ceases any substantial operations with
respect to the assets, but maintains their ownership with a
principal purpose to avoid P's taking into account its excess loss
account in S's stock.
(b) Analysis. Under paragraph (c)(1)(iii)(A) of this section,
P's excess loss account ordinarily is taken into account at the time
substantially all of S's assets are treated as disposed of,
abandoned, or destroyed for Federal income tax purposes. Under
paragraph (e) of this section, however, S's assets are not taken
into account at the beginning of Year 6 for purposes of applying
paragraph (c)(1)(iii)(A) of this section. Consequently, S is treated
as worthless at the beginning of Year 6, and P's $110 excess loss
account is taken into account.
(h) Effective date--(1) Application. This section applies with
respect to determinations of the basis of (including an excess loss
account in) the stock of a member in consolidated return years
beginning on or after January 1, 1995. If this section applies, basis
(and excess loss accounts) must be determined or redetermined as if
this section were in effect for all years (including, for example, the
consolidated return years of another consolidated group to the extent
adjustments during those consolidated return years are still
reflected). Any such determination or redetermination does not,
however, affect any prior period.
(2) Dispositions of stock before effective date--(i) In general. If
P was treated as disposing of stock of S in a tax year beginning before
January 1, 1995 (including, for example, a deemed disposition because S
was worthless) under the rules of this section then in effect, the
amount of P's income, gain, deduction, or loss, and the stock basis
reflected in that amount, are not redetermined under paragraph (h)(1)
of this section. See paragraph (h)(3) of this section for the
applicable rules.
(ii) Intercompany amounts. For purposes of this paragraph (h)(2), a
disposition does not include a transaction to which Sec. 1.1502-13,
Sec. 1.1502-13T, Sec. 1.1502-14, or Sec. 1.1502-14T applies. Instead,
the transaction is deemed to occur as the income, gain, deduction, or
loss (if any) is taken into account.
(3) Prior law. For prior determinations, see prior regulations
under section 1502 as in effect with respect to the determination. See,
e.g., Sec. 1.1502-19 as contained in the 26 CFR part 1 edition revised
as of April 1, 1994.
Par. 10. Section 1.1502-20 is amended as follows:
1. Paragraphs (a)(1) and (a)(3)(ii) are revised.
2. The last sentence of paragraph (a)(4) is removed.
3. The introductory text in paragraph (a)(5) is revised.
4. In paragraph (a)(5), paragraph (iii) in Example 6 is removed.
5. The last sentence of paragraph (b)(4) is removed.
6. In paragraph (b)(6), the last sentence of paragraph (iv) in
Example 5 is revised.
7. Paragraphs (c)(1) (i) and (ii) are revised.
8. Paragraphs (c)(2)(i)(A)(1), (B), and (D) are revised.
9. The first sentence of the concluding text of paragraph (c)(2)(i)
appearing immediately after paragraph (c)(2)(i)(D) is revised.
10. Paragraphs (c)(2) (ii) and (iii) are revised.
11. Paragraph (c)(2)(vii) is added.
12. Paragraph (c)(4) is amended as follows:
a. The heading for Example 1 and paragraphs (ii) and (iii) of
Example 1 are revised.
b. Example 2 is revised.
c. The fifth sentence of paragraph (i) of Example 3 is revised.
d. Paragraphs (ii) and (iii) of Example 3 are revised.
e. Paragraph (ii) of Example 6 is revised.
f. Example 7 is revised.
13. Paragraph (e)(3) is amended as follows:
a. Example 1 is revised.
b. Example 2 is amended by replacing the reference to
``Sec. 1.267(f)-2T(d)(2)'' in paragraph (ii) with ``section 267(f)''.
c. Example 8 is removed.
14. Paragraph (f) is revised.
15. Paragraph (g)(3) is removed, and paragraph (g)(4) is
redesignated as paragraph (g)(3).
16. Newly designated paragraph (g)(3) is amended by revising
paragraphs (i) and (iii) of Example 1, paragraphs (i) and (iv) of
Example 2, and paragraph (iv) of Example 3.
17. The added and revised provisions read as follows:
Sec. 1.1502-20 Loss disallowance.
(a) Loss disallowance--(1) General rule. No deduction is allowed
for any loss recognized by a member with respect to the disposition of
stock of a subsidiary. See also Secs. 1.1502-15(b) (stock losses
attributable to certain pre-1966 distributions) and 1.1502-80(c)
(deferring the treatment of stock of members as worthless under section
165(g)).
* * * * *
(3) * * *
(ii) Overriding events. For purposes of paragraph (a)(3)(i) of this
section, the following are overriding events:
(A) The stock ceases to be owned by a member of the consolidated
group.
(B) The stock is canceled or redeemed (regardless of whether it is
retired or held as treasury stock).
(C) The stock is treated as disposed of under Sec. 1.1502-
19(c)(1)(ii)(B) or (c)(1)(iii).
* * * * *
(5) Examples. For purposes of the examples in this section, unless
otherwise stated, all corporations have only one class of stock
outstanding, all groups file consolidated returns on a calendar-year
basis, the facts set forth the only corporate activity, all
transactions are between unrelated persons, and tax liabilities are
disregarded. The basis of each asset is the same for determining
earnings and profits adjustments and taxable income. References to the
investment adjustment system are references to the rules of
Secs. 1.1502-19, 1.1502-32 and 1.1502-33. The principles of this
paragraph (a) are illustrated by the following examples.
* * * * *
(b) * * *
(6) * * *
* * * * *
Example 5. * * *
(iv) * * * However, the subsequent deconsolidation of the T
stock is an overriding event under paragraph (a)(3)(ii) of this
section, and paragraph (a)(1) of this section applies to the loss
immediately before the deconsolidation.
* * * * *
(c) * * *
(1) * * *
(i) Extraordinary gain dispositions. The amount of income or gain
(or its equivalent), net of directly related expenses, that is
allocated to the share from extraordinary gain dispositions.
(ii) Positive investment adjustments. The amount of the positive
adjustment (if any) with respect to the share under Sec. 1.1502-32 for
each consolidated return year, but only to the extent the amount
exceeds the amount described in paragraph (c)(1)(i) of this section for
the year.
* * * * *
(2) * * *
(i) * * *
(A) * * *
(1) A capital asset as defined in section 1221 (determined without
the application of any other rules of law).
* * * * *
(B) A positive section 481(a) adjustment.
* * * * *
(D) Any other event (or item) identified in guidance published in
the Internal Revenue Bulletin.
An extraordinary gain disposition is taken into account under paragraph
(c)(1)(i) of this section only if it occurs on or after November 19,
1990. * * *
(ii) Positive investment adjustments. For purposes of paragraph
(c)(1)(ii) of this section, a positive adjustment under Sec. 1.1502-32
is the sum of the amounts under Sec. 1.1502-32(b)(2) (i) through (iii)
for the consolidated return year (the adjustment determined without
taking distributions into account). However, amounts included in any
loss carryover are taken into account in the year they arise rather
than the year absorbed.
(iii) Applicable amounts. Amounts are described in paragraphs
(c)(1)(i) and (ii) of this section only to the extent they are
reflected in the basis of the share, directly or indirectly,
immediately before the disposition or deconsolidation. For this
purpose, an amount is reflected in the basis of a share if the share's
basis would have been different without the amount. However, amounts
included in any loss carryover are taken into account in the year they
arise rather than the year absorbed.
* * * * *
(vii) Disallowance amounts applied only once. The amounts described
in paragraph (c)(1) of this section are not applied more than once to
disallow a loss, reduce basis, or reattribute loss under this section.
* * * * *
(4) * * *
Example 1. Allowable loss attributable to lost built-in gain. *
* *
(ii) The amount of the $100 loss disallowed under paragraph
(a)(1) of this section may not exceed the amount determined under
paragraph (c)(1) of this section. Under paragraphs (c)(2) (i) and
(iii) of this section, T's $40 gain is from an extraordinary gain
disposition and the amount is reflected in the basis of the T stock
under Sec. 1.1502-32 immediately before the disposition. Thus, the
gain is described in paragraph (c)(1)(i) of this section. Because
this amount is the only amount described in paragraph (c)(1) of this
section, the amount of P's $100 loss that is disallowed under
paragraph (a)(1) of this section is limited to $40. (No amount is
described in paragraph (c)(1)(ii) of this section because the amount
of T's positive investment adjustments does not exceed the amount
included under paragraph (c)(1)(i) of this section.)
(iii) The results would be the same if the asset, instead of
being owned by T, is owned by a partnership in which T is a partner
and T is allocated the $40 of gain under section 704(b). Under
paragraphs (c)(2) (i) and (iii) of this section, T's $40 gain is
from an extraordinary gain disposition, and the gain is reflected in
the basis of the T stock under Sec. 1.1502-32 immediately before the
disposition.
Example 2. Extraordinary gain dispositions. (i) Individual A
forms T. P buys all the stock of T from A for $100 in Year 1, and T
becomes a member of the P group. T owns a capital asset, asset 1,
with a basis of $0 and a value of $100. T sells asset 1 for $100 in
Year 1 and invests the proceeds in a trade or business asset, asset
2. For Year 2, asset 2 produces $30 of gross operating income and
$20 of cost recovery deductions. On December 31 of Year 2, asset 2
has an $80 adjusted basis and T disposes of asset 2 for $85;
however, because T incurs $20 of expenses directly related to the
sale of asset 2, the disposition produces a $15 loss that is taken
into account in the determination of taxable income or loss under
Sec. 1.1502-32(b)(2)(i) (the loss offsets T's $10 of operating
income for Year 2, as well as $5 of operating income of P in that
year). Under the investment adjustment system, P's basis in the T
stock increases by $95, to $195, because T has $110 of income and a
$15 loss. P sells the T stock for $95 in Year 5 and recognizes a
$100 loss.
(ii) Under paragraphs (c)(2) (i) and (iii) of this section, the
$100 gain from the disposition of asset 1 is from an extraordinary
gain disposition and is reflected in the basis of the T stock. Thus,
the gain is described in paragraph (c)(1)(i) of this section. The
sale of asset 2 is not taken into account under paragraph (c)(1)(i)
of this section because, net of directly related expenses, T does
not have income or gain from the sale. (No amount is described under
paragraph (c)(1)(ii) of this section because T's positive investment
adjustments are taken into account under paragraph (c)(1)(i) of this
section.) Because the $100 amount described under paragraph
(c)(1)(i) of this section equals P's $100 loss from the disposition
of the T stock, all of the loss is disallowed.
Example 3. * * * (i) * * * T invests the operating income in
another asset that produces a $25 operating loss for Year 2. * * *
(ii) Under paragraph (c)(1)(ii) of this section, the $100 of
income from Year 1 is a positive investment adjustment. The amount
is not reduced by the $25 operating loss for Year 2. Because the
$100 amount described under paragraph (c)(1)(ii) of this section
equals S's $100 loss from the disposition of the T stock, all of the
loss is disallowed.
(iii) Under paragraph (c)(2)(iv) of this section, the results
would have been the same if, prior to the decline in the value of
the first asset (the value of the T stock was $200, $100 cash and a
$100 asset), S had sold the T stock to P for $200 at no gain or
loss, and P then sold the T stock to an unrelated buyer for $75
(after the $100 decline in the value of the asset and the $25
operating loss) and recognized a $100 loss. T had $100 of income
that resulted in a positive adjustment under the investment
adjustment system and is reflected, within the meaning of paragraph
(c)(2)(iii) of this section, in the basis of the T stock. The income
and investment adjustments with respect to the T stock are not
reduced or eliminated for purposes of paragraph (c)(1)(ii) of this
section by reason of P's purchase of the stock, because P is a
person related to S within the meaning of section 267(b).
* * * * *
Example 6. * * *
(ii) Although T has a $100 gain from extraordinary gain
dispositions, the gain is not reflected in P's basis in the T stock
within the meaning of paragraph (c)(2)(iii) of this section. P's
basis reflects the stock's value at the time of P's purchase, and is
determined without regard to whether T recognized the gain before
the purchase. Thus, no part of T's gain is described in paragraph
(c)(1) of this section, and no part of the $20 loss is disallowed
under paragraph (a) of this section. (For rules that apply if A and
P are related persons, see paragraph (c)(2)(iv) of this section.)
Example 7. Adjustments to stock basis under applicable rules of
law. (i) Individual A forms T, and T's assets subsequently
appreciate. T borrows $100 on a nonrecourse basis secured by the
appreciated assets. P buys all of the stock of T from A for $150.
After becoming a member of the P group, T has a $100 operating loss
that is absorbed in the determination of consolidated taxable income
and P's basis in the T stock is reduced to $50 under Sec. 1.1502-32.
Because T's assets have declined in value, T's creditors discharge
$60 of T's indebtedness. The $60 discharge is not included in T's
gross income under section 108(a), but no attributes are reduced
under section 108(b).
(ii) Under paragraph (c)(2)(i) of this section, the discharge of
indebtedness is an extraordinary gain disposition. Under
Sec. 1.1502-32(b)(3)(ii), however, the $60 discharge of indebtedness
is not treated as tax-exempt income that increases P's basis in the
T stock. Consequently, under paragraph (c)(2)(iii) of this section,
T's discharge of indebtedness income is not reflected in P's basis
in the T stock. Thus, there is no amount under paragraph (c)(1) of
this section.
(iii) The facts are the same as in paragraph (i) of this
Example, except that $60 of T's operating loss is not absorbed and
is included in a consolidated net operating loss that is carried
over under Sec. 1.1502-21, and the $60 is eliminated from the
carryover under section 108(b) as a result of T's discharge of
indebtedness. The absorption of $40 of T's loss reduces P's basis in
the T stock from $150 to $110. The $60 discharge of indebtedness is
treated as tax-exempt income that increases P's basis in the T
stock, and the $60 attribute reduction is treated as a noncapital,
nondeductible expense that reduces P's basis in the T stock. Thus,
P's basis in T's stock remains $110 following the discharge and
attribute reduction. Because P's basis is $110, rather than $50, the
discharge of indebtedness income is reflected in P's basis for
purposes of paragraph (c)(2)(iii) of this section. Thus, the amount
under paragraph (c)(1)(i) of this section is $60.
* * * * *
(e) * * *
(3) * * *
Example 1. Shifting of value. (i) P buys all the stock of T for
$100, and T becomes a member of the P group. T has an asset with a
basis of $0 and a value of $100. With the view described in
paragraph (e)(1) of this section, P transfers land with a value of
$100 to T in exchange for preferred stock with a $200 redemption
price and liquidation preference. The $100 redemption premium (the
excess of the $200 redemption price over the $100 issue price)
ultimately increases the value of the preferred stock from $100 to
$200 (and decreases the value of the common stock). T sells the
built-in gain asset for $100, and P's aggregate basis in S's common
and preferred stock increases to $300. In addition, as a result of a
cumulative redetermination under Sec. 1.1502-32(c)(4), P's basis in
the T preferred stock increases from $100 to $200 and P's basis in
the common stock remains $100. P subsequently sells the common stock
at a loss.
(ii) Under section 305, the redemption premium is treated as a
distribution of property to which section 301 applies. Under
Secs. 1.1502-14 and 1.1502-32, P's aggregate basis in the preferred
and common stock is unaffected by the deemed distributions.
(iii) P's loss on the sale of the common stock is disallowed
under paragraph (e)(1) of this section. This disallowance prevents
the preferred stock from shifting value and stock basis adjustments
from the common stock to avoid the disallowance of loss under this
section.
* * * * *
(f) No tiering up of certain adjustments--(1) General rule. If the
basis of stock of a subsidiary (S) owned by a another member (P) is
reduced under this section on the deconsolidation of the S stock, no
corresponding adjustment is made under Sec. 1.1502-32 to the basis of
the stock of P if there is a disposition or deconsolidation of the P
stock in the same transaction. If there is a disposition or
deconsolidation in the same transaction of less than all the stock of
P, appropriate adjustments must be made under Sec. 1.1502-32 with
respect to P (and any higher-tier members).
(2) Example. The principles of this paragraph (f) are illustrated
by the following example.
Example. (i) P, the common parent of a group, owns all the stock
of S, S owns all the stock of S1, and S1 owns all the stock of S2.
P's basis in the S stock is $100, S's basis in the S1 stock is $100,
and S1's basis in the S2 stock is $100. In Year 1, S2 buys all the
stock of T for $100. T has an asset with a basis of $0 and a value
of $100. In Year 2, T sells the asset for $100. Under the investment
adjustment system, the basis of each subsidiary's stock increases
from $100 to $200. In Year 6, S sells all the stock of S1 for $100
to A, an individual, and recognizes a loss of $100. S1, S2, and T
are not members of a consolidated group immediately after the sale
because the new S1 group does not file a consolidated return for its
first tax year.
(ii) Under paragraph (a)(1) of this section, no deduction is
allowed to S for its loss from the sale of the S1 stock. Under
Sec. 1.1502-32(b)(3)(iii), S's disallowed loss is treated as a
noncapital, nondeductible expense for Year 6 that reduces P's basis
in the S stock. (Under Sec. 1.1502-33, S's earnings and profits for
Year 6 are reduced by the amount of S's disallowed loss for earnings
and profits purposes and, under Sec. 1.1502-33(b), this reduction is
reflected in P's earnings and profits.)
(iii) Under paragraphs (b)(1) and (f)(1) of this section,
because the stock of T and S2 are deconsolidated as a result of S's
sale of the S1 stock, the basis of their stock must be reduced
immediately before the sale from $200 to $100 (the value immediately
before the deconsolidation). Under Sec. 1.1502-32(b)(3)(iii), the
basis reductions are treated as noncapital, nondeductible expenses
for Year 6. Under paragraph (f)(2) of this section, however, because
the S2 stock is deconsolidated in the same transaction, the basis
reduction to the T stock does not tier up under Sec. 1.1502-
32(a)(3). Similarly, because the S1 stock is disposed of in the same
transaction, the basis reduction to the S2 stock also does not tier
up. (Comparable treatment applies for purposes of earnings and
profits under Sec. 1.1502-33.)
(g) * * *
(3) * * *
Example 1. * * * (i) P, the common parent of a group, forms S
with a $100 contribution. For Year 1, S has a $60 operating loss
that is not absorbed and is included in the group's consolidated net
operating loss that is carried over under Sec. 1.1502-21. Under
Sec. 1.1502-32(b)(3)(i), P's basis in the S stock is not reduced to
reflect S's loss because the loss is not absorbed. Under
Sec. 1.1502-33(b), S's deficit in earnings and profits is reflected
in P's earnings and profits even though the loss is not absorbed for
tax purposes. During Year 2, S's remaining assets appreciate in
value and P sells the S stock for $55. But for an election to
reattribute losses under paragraph (g) of this section, P would have
a $45 loss from the sale that would be disallowed.
* * * * *
(iii) Under Sec. 1.1502-32(b)(3)(iii), the reattribution of $45
of loss is a noncapital, nondeductible expense that reduces P's
basis in the S stock from $100 to $55 immediately before the
disposition. Consequently, P does not recognize any gain or loss
from the disposition.
* * * * *
Example 2. * * * (i) P, the common parent of a group, forms S
with a $100 contribution. S then forms T with a $40 contribution and
T borrows $60. For Year 1, S has a $30 operating loss and T has a
$55 operating loss. The losses are not absorbed and are included in
the group's consolidated net operating loss that is carried over
under Sec. 1.1502-21. Under Sec. 1.1502-32(b)(3)(i), P's basis in
the S stock, and S's basis in the T stock, are not reduced to
reflect the S and T losses because the group is unable to absorb the
losses. (Under Sec. 1.1502-33(b), the deficits in earnings and
profits of S and T are tiered up for earnings and profits purposes
even though not absorbed for tax purposes.) During Year 2, P sells
the S stock for $30 ($100 invested, minus S's $30 loss and $40
unrealized loss from its investment in the T stock). But for an
election to reattribute losses under paragraph (g) of this section,
P would have a $70 loss from the sale, which would be disallowed.
* * * * *
(iv) Under Sec. 1.1502-32(b)(3)(iii), the reattribution of loss
is a noncapital, nondeductible expense that reduces P's basis in the
S stock to $60 immediately before the disposition. Consequently, P
recognizes only a $30 loss from the disposition of its S stock ($30
sale proceeds and $60 basis), and this loss is disallowed.
Example 3. * * *
(iv) Under Sec. 1.1502-32(b)(3)(iii), the reattribution of loss
is a noncapital, nondeductible expense that reduces P's basis in the
S stock to $60 immediately before the disposition. Consequently, P
recognizes no gain or loss from the disposition of its S stock. For
P's treatment of the $40 reattributed loss, see Sec. 1.1502-1(f).
* * * * *
Par. 11. Section 1.1502-31 is revised to read as follows:
Sec. 1.1502-31 Stock basis after a group structure change.
(a) In general--(1) Overview. If one corporation (P) succeeds
another corporation (T) under the principles of Sec. 1.1502-75(d) (2)
or (3) as the common parent of a consolidated group in a group
structure change, the basis of members in the stock of the former
common parent (or the stock of a successor) is adjusted or determined
under this section. See Sec. 1.1502-33(f)(1) for the definition of
group structure change. For example, if P owns all of the stock of
another corporation (S), and T merges into S in a group structure
change that is a reorganization described in section 368(a)(2)(D) in
which P becomes the common parent of the T group, P's basis in S's
stock must be adjusted to reflect the change in S's assets and
liabilities. The rules of this section coordinate with the earnings and
profits adjustments required under Sec. 1.1502-33(f)(1), generally
conforming the results of transactions in which the T group continues
under Sec. 1.1502-75 with P as the common parent. By preserving in P
the relationship between T's earnings and profits and asset basis,
these adjustments limit possible distortions under section 1502 (e.g.,
in the deconsolidation rules for earnings and profits under
Sec. 1.1502-33(e), and the continued filing requirements under
Sec. 1.1502-75(a)). This section applies whether or not T continues to
exist after the group structure change.
(2) Application of other rules of law. The rules of this section
are in addition to other rules of law. The provisions of this section
and other rules of law must not have the effect of duplicating an
amount in P's basis in S's stock.
(b) General rules. Except as otherwise provided in this section--
(1) Asset acquisitions. If a corporation acquires the former common
parent's assets (and any liabilities assumed or to which the assets are
subject) in a group structure change, the basis of members in the stock
of the acquiring corporation is adjusted immediately after the group
structure change to reflect the acquiring corporation's allocable share
of the former common parent's net asset basis as determined under
paragraph (c) of this section. For example, if S acquires all of T's
assets in a group structure change that is a reorganization described
in section 368(a)(2)(D), P's basis in S's stock is adjusted to reflect
T's net asset basis. If P owned some of T's stock before the group
structure change, the results would be the same because P's basis in
the T stock is not taken into account in determining P's basis in S's
stock. If T's net asset basis is a negative amount, it reduces P's
basis in S's stock and, if the reduction exceeds P's basis in S's
stock, the excess is P's excess loss account in S's stock. See
Sec. 1.1502-19 for rules treating P's excess loss account as negative
basis, and treating a reference to P's basis in S's stock as including
an excess loss account.
(2) Stock acquisitions. If a corporation acquires stock of the
former common parent in a group structure change, the basis of the
members in the former common parent's stock immediately after the group
structure change (including any stock of the former common parent owned
before the group structure change) is redetermined in accordance with
the results for an asset acquisition described in paragraph (b)(1) of
this section. For example, if all of T's stock is contributed to P in a
group structure change to which section 351 applies, P's basis in T's
stock is T's net asset basis, rather than the amount determined under
section 362. Similarly, if S merges into T in a group structure change
described in section 368(a)(2)(E), P's basis in T's stock is the basis
that P would have in S's stock under paragraph (b)(1) of this section
if T had merged into S in a group structure change described in section
368(a)(2)(D).
(c) Net asset basis. The former common parent's net asset basis is
the basis it would have in the stock of a newly formed subsidiary, if--
(1) The former common parent transferred its assets (and any
liabilities assumed or to which the assets are subject) to the
subsidiary in a transaction to which section 351 applies;
(2) The former common parent and the subsidiary were members of the
same consolidated group (see Sec. 1.1502-80(d) for the non-application
of section 357(c) to the transfer); and
(3) The asset basis taken into account is each asset's basis
immediately after the group structure change (e.g., taking into account
any income or gain recognized in the group structure change and
reflected in the asset's basis).
(d) Additional adjustments. In addition to the adjustments in
paragraph (b) of this section, the following adjustments are made:
(1) Consideration not provided by P. The basis is reduced to
reflect the fair market value of any consideration not provided by the
member. For example, if S acquires T's assets in a group structure
change described in section 368(a)(2)(D), and S provides an appreciated
asset (e.g., stock of P) as partial consideration in the transaction,
P's basis in S's stock is reduced by the fair market value of the
asset.
(2) Allocable share--(i) Asset acquisitions. If a corporation
receives less than all of the former common parent's assets and
liabilities in the group structure change, the former common parent's
net asset basis taken into account under paragraph (b)(1) of this
section is adjusted accordingly.
(ii) Stock acquisitions. If a corporation owns less than all of the
former common parent's stock immediately after a group structure change
described in paragraph (b)(2) of this section, the percentage of the
former common parent's net asset basis taken into account equals the
percentage (by fair market value) of the former common parent's stock
owned immediately after the group structure change. For example, if P
owns less than all of the former common parent's stock immediately
after the group structure change, only an allocable part of the basis
determined under this section is reflected in the shares owned by P
(and the amount allocable to shares owned by nonmembers has no effect
on the basis of their shares).
(3) Allocation among shares of stock. The basis determined under
this section is allocated among shares under the principles of section
358. For example, if P owns multiple classes of the former common
parent's stock immediately after the group structure change, only an
allocable part of the basis determined under this section is reflected
in the basis of each share. See Sec. 1.1502-19(d), for special
allocations with respect to excess loss accounts.
(4) Higher-tier members. To the extent that the former common
parent is owned by members other than the new common parent, the basis
of members in the stock of all subsidiaries owning, directly or
indirectly, in whole or in part, an interest in the former common
parent's assets or liabilities is adjusted in accordance with the
principles of this section. The adjustments are applied in the order of
the tiers, from the lowest to the highest.
(e) Waiver of loss carryovers of former common parent --(1) General
rule. An irrevocable election may be made to treat all or any portion
of a loss carryover attributable to the common parent as expiring for
all Federal income tax purposes immediately before the group structure
change. Thus, if the loss carryover is treated as expiring under the
election, it will not result in a negative adjustment to the basis of
P's stock under Sec. 1.1502-32(b).
(2) Election. The election described in this paragraph (e) must be
made in a separate statement entitled ``ELECTION TO TREAT LOSS
CARRYOVER AS EXPIRING UNDER Sec. 1.1502-31(e).'' The statement must be
filed with the consolidated group's return for the year that includes
the group structure change, and it must be signed by the former and the
new common parent. The statement must identify the amount of each loss
carryover deemed to expire (or the amount of each loss carryover deemed
not to expire, with any balance of any loss carryovers being deemed to
expire).
(f) Predecessors and successors. For purposes of this section, any
reference to a corporation includes a reference to a successor or
predecessor as the context may require. See Sec. 1.1502-32(f) for
definitions of predecessor and successor.
(g) Examples. For purposes of the examples in this section, unless
otherwise stated, all corporations have only one class of stock
outstanding, the tax year of all persons is the calendar year, all
persons use the accrual method of accounting, the facts set forth the
only corporate activity, all transactions are between unrelated
persons, and tax liabilities are disregarded. The principles of this
section are illustrated by the following examples.
Example 1. Forward triangular merger. (a) Facts. P is the common
parent of one group and T is the common parent of another. T has
assets with an aggregate basis of $60 and fair market value of $100
and no liabilities. T's shareholders have an aggregate basis of $50
in T's stock. In Year 1, pursuant to a plan, P forms S and T merges
into S with the T shareholders receiving $100 of P stock in exchange
for their T stock. The transaction is a reorganization described in
section 368(a)(2)(D). The transaction is also a reverse acquisition
under Sec. 1.1502- 75(d)(3) because the T shareholders, as a result
of owning T's stock, own more than 50% of the value of P's stock
immediately after the transaction. Thus, the transaction is a group
structure change under Sec. 1.1502-33(f)(1), and P's earnings and
profits are adjusted to reflect T's earnings and profits immediately
before T ceases to be the common parent of the T group.
(b) Analysis. Under paragraph (b)(1) of this section, P's basis
in S's stock is adjusted to reflect T's net asset basis. Under
paragraph (c) of this section, T's net asset basis is $60, the basis
T would have in the stock of a subsidiary under section 358 if T had
transferred all of its assets and liabilities to the subsidiary in a
transaction to which section 351 applies. Thus, P has a $60 basis in
S's stock.
(c) Pre-existing S. The facts are the same as in paragraph (a)
of this Example 1, except that P has owned the stock of S for
several years and P has a $50 basis in the S stock before the merger
with T. Under paragraph (b)(1) of this section, P's $50 basis in S's
stock is adjusted to reflect T's net asset basis. Thus, P's basis in
S's stock is $110 ($50 plus $60).
(d) Excess loss account included in former common parent's net
asset basis. The facts are the same as in paragraph (a) of this
Example 1, except that T has two assets, an operating asset with an
$80 basis and $90 fair market value, and stock of a subsidiary with
a $20 excess loss account and $10 fair market value. Under paragraph
(c) of this section, T's net asset basis is $60 ($80 minus $20). See
sections 351 and 358, and Sec. 1.1502-19. Consequently, P has a $60
basis in S's stock. Under section 362 and Sec. 1.1502-19, S has an
$80 basis in the operating asset and a $20 excess loss account in
the stock of the subsidiary.
(e) Liabilities in excess of basis. The facts are the same as in
paragraph (a) of this Example 1, except that T's assets have a fair
market value of $170 (and $60 basis) and are subject to $70 of
liabilities. Under paragraph (c) of this section, T's net asset
basis is ($10) ($60 minus $70). See sections 351 and 358, and
Secs. 1.1502-19 and 1.1502-80(d). Thus, P has a $10 excess loss
account in S's stock. Under section 362, S has a $60 basis in its
assets (which are subject to $70 of liabilities). (Under paragraph
(a)(2) of this section, because the liabilities are taken into
account in determining net asset basis under paragraph (c) of this
section, the liabilities are not also taken into account as
consideration not provided by P under paragraph (d)(1) of this
section.)
(f) Consideration provided by S. The facts are the same as in
paragraph (a) of this Example 1, except that P forms S with a $100
contribution at the beginning of Year 1, and during Year 6, pursuant
to a plan, S purchases $100 of P stock and T merges into S with the
T shareholders receiving P stock in exchange for their T stock.
Under paragraph (b)(1) of this section, P's $100 basis in S's stock
is increased by $60 to reflect T's net asset basis. Under paragraph
(d)(1) of this section, P's basis in S's stock is decreased by $100
(the fair market value of the P stock) because the P stock purchased
by S and used in the transaction is consideration not provided by P.
(g) Appreciated asset provided by S. The facts are the same as
in paragraph (a) of this Example 1, except that P has owned the
stock of S for several years, and the shareholders of T receive $60
of P stock and an asset of S with a $30 adjusted basis and $40 fair
market value. S recognizes a $10 gain from the asset under section
1001. Under paragraph (b)(1) of this section, P's basis in S's stock
is increased by $60 to reflect T's net asset basis. Under paragraph
(d)(1) of this section, P's basis in S's stock is decreased by $40
(the fair market value of the asset provided by S). In addition, P's
basis in S's stock is increased under Sec. 1.1502-32(b) by S's $10
gain.
(h) Depreciated asset provided by S. The facts are the same as
in paragraph (a) of this Example 1, except that P has owned the
stock of S for several years, and the shareholders of T receive $60
of P stock and an asset of S with a $50 adjusted basis and $40 fair
market value. S recognizes a $10 loss from the asset under section
1001. Under paragraph (b)(1) of this section, P's basis in S's stock
is increased by $60 to reflect T's net asset basis. Under paragraph
(d)(1) of this section, P's basis in S's stock is decreased by $40
(the fair market value of the asset provided by S). In addition, S's
$10 loss is taken into account under Sec. 1.1502-32(b) in
determining P's basis adjustments under that section.
Example 2. Stock acquisition. (a) Facts. P is the common parent
of one group and T is the common parent of another. T has assets
with an aggregate basis of $60 and fair market value of $100 and no
liabilities. T's shareholders have an aggregate basis of $50 in T's
stock. Pursuant to a plan, P forms S and S acquires all of T's stock
in exchange for P stock in a transaction described in section
368(a)(1)(B). The transaction is also a reverse acquisition under
Sec. 1.1502-75(d)(3). Thus, the transaction is a group structure
change under Sec. 1.1502-33(f)(1), and the earnings and profits of P
and S are adjusted to reflect T's earnings and profits immediately
before T ceases to be the common parent of the T group.
(b) Analysis. Under paragraph (d)(4) of this section, although S
is not the new common parent of the T group, adjustments must be
made to S's basis in T's stock in accordance with the principles of
this section. Although S's basis in T's stock would ordinarily be
determined under section 362 by reference to the basis of T's
shareholders in T's stock immediately before the group structure
change, under the principles of paragraph (b)(2) of this section,
S's basis in T's stock is determined by reference to T's net asset
basis. Thus, S's basis in T's stock is $60.
(c) Higher-tier adjustments. Under paragraph (d)(4) of this
section, P's basis in S's stock is adjusted to $60 (to be consistent
with the adjustment to S's basis in T's stock).
(d) Cross ownership. The facts are the same as in paragraph (a)
of this Example 2, except that S has owned 10% of T's stock for
several years and, pursuant to the plan, S acquires the remaining
90% of T's stock in exchange for P stock. The results are the same
as in paragraphs (b) and (c) of this Example 2, because S's basis in
the initial 10% of T's stock is redetermined under this section.
(e) Allocable share. The facts are the same as in paragraph (a)
of this Example 2, except that P owns only 90% of S's stock
immediately after the group structure change. S's basis in T's stock
is the same as in paragraph (b) of this Example 2. Under paragraph
(d)(2) of this section, P's basis in its S stock is adjusted to $54
(90% of S's $60 adjustment).
Example 3. Taxable stock acquisition. (a) Facts. P is the common
parent of one group and T is the common parent of another. T has
assets with an aggregate basis of $60 and fair market value of $100
and no liabilities. T's shareholders have an aggregate basis of $50
in T's stock. Pursuant to a plan, P acquires all of T's stock in
exchange for $70 of P's stock and $30 in a transaction that is a
group structure change under Sec. 1.1502-33(f)(1). P's acquisition
of T's stock is a taxable transaction. (Because of P's use of cash,
the acquisition is not a transaction described in section
368(a)(1)(B).)
(b) Analysis. Under paragraph (b)(2) of this section, P's basis
in T's stock is adjusted to reflect T's net asset basis. Thus,
although P's basis in T's stock would ordinarily be a cost basis of
$100, P's basis in T's stock under this section is $60.
(h) Effective date--(1) General rule. This section applies to group
structure changes occurring in consolidated return years beginning on
or after January 1, 1995.
(2) Prior law. For prior years, see prior regulations under section
1502 as in effect with respect to the transaction. See, e.g.,
Sec. 1.1502-31T as contained in the 26 CFR part 1 edition revised as of
April 1, 1994.
Sec. 1.1502-31T [Removed]
Par. 12. Section 1.1502-31T is removed.
Par. 13. Section 1.1502-32 is revised to read as follows:
Sec. 1.1502-32 Investment adjustments.
(a) In general--(1) Purpose. This section provides rules for
adjusting the basis of the stock of a subsidiary (S) owned by another
member (P). These rules modify the determination of P's basis in S's
stock under applicable rules of law by adjusting P's basis to reflect
S's distributions and S's items of income, gain, deduction, and loss
taken into account for the period that S is a member of the
consolidated group. The purpose of the adjustments is to treat P and S
as a single entity so that consolidated taxable income reflects the
group's income. For example, if P forms S with a $100 contribution, and
S takes into account $10 of income, P's $100 basis in S's stock under
section 358 is increased by $10 under this section to prevent S's
income from being taken into account a second time on P's disposition
of S's stock. Comparable adjustments are made for tax-exempt income and
noncapital, nondeductible expenses that S takes into account, to
preserve their treatment under the Internal Revenue Code.
(2) Application of other rules of law. The rules of this section
are in addition to other rules of law. See, e.g., section 358 (basis
determinations for distributees), section 1016 (adjustments to basis),
Sec. 1.1502-11(b) (limitations on the use of losses), Sec. 1.1502-19
(treatment of excess loss accounts), Sec. 1.1502-20 (additional rules
relating to stock loss), and Sec. 1.1502-31 (basis after a group
structure change). P's basis in S's stock must not be adjusted under
this section and other rules of law in a manner that has the effect of
duplicating an adjustment. See also paragraph (h)(5) of this section
for basis reductions applicable to certain former subsidiaries.
(3) Overview--(i) In general. The amount of the stock basis
adjustments and their timing are determined under paragraph (b) of this
section. Under paragraph (c) of this section, the amount of the
adjustment is allocated among the shares of S's stock. Paragraphs (d)
through (g) of this section provide definitions, an anti-avoidance
rule, successor rules, and recordkeeping requirements.
(ii) Excess loss account. Negative adjustments under this section
may exceed P's basis in S's stock. The resulting negative amount is P's
excess loss account in S's stock. See Sec. 1.1502-19 for rules treating
excess loss accounts as negative basis, and treating references to
stock basis as including references to excess loss accounts.
(iii) Tiering up of adjustments. The adjustments to S's stock under
this section are taken into account in determining adjustments to
higher-tier stock. The adjustments are applied in the order of the
tiers, from the lowest to the highest. For example, if P is also a
subsidiary, P's adjustment to S's stock is taken into account in
determining the adjustments to stock of P owned by other members.
(b) Stock basis adjustments--(1) Timing of adjustments--(i) In
general. Adjustments under this section are made as of the close of
each consolidated return year, and as of any other time (an interim
adjustment) if a determination at that time is necessary to determine a
tax liability of any person. For example, adjustments are made as of
P's sale of S's stock in order to measure P's gain or loss from the
sale, and if P's interest in S's stock is not uniform throughout the
year (e.g., because P disposes of a portion of its S stock, or S issues
additional shares to another person), the adjustments under this
section are made by taking into account the varying interests. An
interim adjustment may be necessary even if tax liability is not
affected until a later time. For example, if P sells only 50% of S's
stock and S becomes a nonmember, adjustments must be made for the
retained stock as of the disposition (whether or not P has an excess
loss account in that stock). Similarly, if S liquidates during a
consolidated return year, adjustments must be made as of the
liquidation (even if the liquidation is tax free under section 332).
(ii) Allocation of items. If Sec. 1.1502-76(b) applies to S for
purposes of an adjustment before the close of the group's consolidated
return year, the amount of the adjustment is determined under that
section. If Sec. 1.1502-76(b) does not apply to the interim adjustment,
the adjustment is determined under the principles of Sec. 1.1502-76(b),
consistently applied, and ratable allocation under the principles of
Sec. 1.1502-76(b)(2)(ii) or (iii) may be used without filing an
election under Sec. 1.1502-76(b)(2). The principles would apply, for
example, if P becomes a nonmember but S remains a member.
(2) Amount of adjustments. P's basis in S's stock is increased by
positive adjustments and decreased by negative adjustments under this
paragraph (b)(2). The amount of the adjustment, determined as of the
time of the adjustment, is the net amount of S's--
(i) Taxable income or loss;
(ii) Tax-exempt income;
(iii) Noncapital, nondeductible expenses; and
(iv) Distributions with respect to S's stock.
(3) Operating rules. For purposes of determining P's adjustments to
the basis of S's stock under paragraph (b)(2) of this section--
(i) Taxable income or loss. S's taxable income or loss is
consolidated taxable income (or loss) determined by including only S's
items of income, gain, deduction, and loss taken into account in
determining consolidated taxable income (or loss), treating S's
deductions and losses as taken into account to the extent they are
absorbed by S or any other member. For this purpose:
(A) To the extent that S's deduction or loss is absorbed in the
year it arises or is carried forward and absorbed in a subsequent year
(e.g., under section 172, 465, or 1212), the deduction or loss is taken
into account under paragraph (b)(2) of this section in the year in
which it is absorbed.
(B) To the extent that S's deduction or loss is carried back and
absorbed in a prior year (whether consolidated or separate), the
deduction or loss is taken into account under paragraph (b)(2) of this
section in the year in which it arises and not in the year in which it
is absorbed.
(ii) Tax-exempt income--(A) In general. S's tax-exempt income is
its income and gain which is taken into account but permanently
excluded from its gross income under applicable law, and which
increases, directly or indirectly, the basis of its assets (or an
equivalent amount). For example, S's dividend income to which
Sec. 1.1502-14(a) applies, and its interest excluded from gross income
under section 103, are treated as tax-exempt income. However, S's
income not recognized under section 1031 is not treated as tax- exempt
income because the corresponding basis adjustments under section
1031(d) prevent S's nonrecognition from being permanent. Similarly, S's
tax-exempt income does not include gain not recognized under section
332 from the liquidation of a lower-tier subsidiary, or not recognized
under section 118 or section 351 from a transfer of assets to S.
(B) Equivalent deductions. To the extent that S's taxable income or
gain is permanently offset by a deduction or loss that does not reduce,
directly or indirectly, the basis of S's assets (or an equivalent
amount), the income or gain is treated as tax-exempt income and is
taken into account under paragraph (b)(3)(ii)(A) of this section. In
addition, the income and the offsetting item are taken into account
under paragraph (b)(3)(i) of this section. For example, if S receives a
$100 dividend with respect to which a $70 dividends received deduction
is allowed under section 243, $70 of the dividend is treated as tax-
exempt income. Accordingly, P's basis in S's stock increases by $100
because the $100 dividend and $70 deduction are taken into account
under paragraph (b)(3)(i) of this section (resulting in $30 of the
increase), and $70 of the dividend is also taken into account under
paragraph (b)(3)(ii)(A) of this section as tax-exempt income (resulting
in $70 of the increase). (See paragraph (b)(3)(iii) of this section if
there is a corresponding negative adjustment under section 1059.)
Similarly, income from mineral properties is treated as tax-exempt
income to the extent it is offset by deductions for depletion in excess
of the basis of the property.
(C) Discharge of indebtedness income--(1) In general. Discharge of
indebtedness income of S that is excluded from gross income under
section 108 is treated as tax-exempt income only to the extent the
discharge is applied to reduce tax attributes (e.g., under section 108
or 1017). Discharge of S's indebtedness is treated as applied to reduce
tax attributes only to the extent the attribute reduction is taken into
account as a reduction under paragraph (b)(3)(iii) of this section.
(2) Expired loss carryovers. If the amount of the discharge exceeds
the amount of the attribute reduction, the excess is nevertheless
treated as applied to reduce tax attributes to the extent a loss
carryover expired without tax benefit, the expiration was taken into
account as a noncapital, nondeductible expense under paragraph
(b)(3)(iii) of this section, and the loss carryover would have been
reduced had it not expired.
(D) Basis shifts. An increase in the basis of S's assets (or an
equivalent as described in paragraph (b)(3)(iv)(B) of this section) is
treated as tax-exempt income to the extent that the increase is not
otherwise taken into account in determining stock basis, it corresponds
to a negative adjustment that is taken into account by the group under
this paragraph (b) (or incurred by the common parent), and it has the
effect (viewing the group in the aggregate) of a permanent recovery of
the reduction. For example, S's basis increase under section 50(c)(2)
is treated as tax-exempt income to the extent the preceding basis
reduction under section 50(c)(1) is reflected in the basis of a
member's stock. On the other hand, if S increases the basis of an asset
as the result of an accounting method change, and the related positive
section 481(a) adjustment is taken into account over time, the basis
increase is not treated as tax-exempt income.
(iii) Noncapital, nondeductible expenses--(A) In general. S's
noncapital, nondeductible expenses are its deductions and losses that
are taken into account but permanently disallowed or eliminated under
applicable law in determining its taxable income or loss, and that
decrease, directly or indirectly, the basis of its assets (or an
equivalent amount). For example, S's Federa
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