Section 1059 Extraordinary Dividends

[[Page 30845]]

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[CO-9-96]

RIN 1545-AU16

Section 1059 Extraordinary Dividends

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to

certain distributions made by corporations to certain corporate

shareholders. The proposed regulations are necessary to clarify that

certain distributions in redemption of stock are treated as

extraordinary dividends notwithstanding provisions that otherwise might

exempt the distributions from extraordinary dividend treatment.

Corporations that receive a distribution in redemption of stock may be

affected if the redemption is either part of a partial liquidation of

the redeeming corporation or is not pro rata as to all shareholders.

This document also provides notice of a public hearing on these

proposed regulations.

DATES: Written comments and outlines of topics to be discussed at the

public hearing scheduled for Wednesday, October 2, 1996, must be

received by September 16, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (CO-9-96), room 5228,

Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, submissions may be hand delivered between

the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (CO-9-96), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC. The public hearing will be held in room 3313, Internal

Revenue Building, 1111 Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the hearing, Mike

Slaughter, Regulations Unit, Assistant Chief Counsel (Corporate), at

(202) 622-7190 (not a toll-free number). Concerning the proposed

regulations, Richard K. Passales at (202) 622-7530 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to the Income Tax

Regulations (26 CFR part 1) relating to the extraordinary dividend

provisions under section 1059 of the Internal Revenue Code. Section

1059 was added by the Deficit Reduction Act of 1984, Public Law 98-369.

One of the purposes of section 1059 is to prevent a corporate

shareholder from creating an artificial loss on stock. See General

Explanation of the Revenue Provisions of the Deficit Reduction Act of

1984.

Section 1059(a) generally requires a corporation that receives an

extraordinary dividend on stock it has not held for at least two years

before the dividend announcement date to reduce its basis (but not

below zero) immediately before any sale or disposition of the stock by

the nontaxed portion of the dividend (generally, the amount of the

dividends received deduction). If the nontaxed portion of the dividend

exceeds basis, the excess generally is treated as additional gain

recognized when the stock is sold. Section 1059(c) generally defines an

extraordinary dividend as a dividend that equals or exceeds the

threshold percentage of the taxpayer's adjusted basis in such stock.

Sections 1059(d)(6), (e)(1), and (e)(2) were enacted as part of the

Tax Reform Act of 1986. Each of those sections affects the definition

of extraordinary dividends contained in section 1059(c). Section

1059(d)(6) generally excludes an extraordinary dividend from section

1059(a) treatment if the distributee is an original shareholder of the

distributing corporation and the earnings and profits from which the

dividend is paid are attributable solely to the original shareholder.

Section 1059(e)(2) generally excludes a dividend from extraordinary

dividend treatment if it is a ``qualifying dividend.'' A dividend

generally is a qualifying dividend if the distributee and distributing

corporations are affiliated at the time of the distribution and the

distribution is out of affiliated year earnings and profits. Both

sections 1059(d)(6) and (e)(2) contemplate that the distribution that

otherwise would be an extraordinary dividend subject to section 1059(a)

is derived from earnings and profits accumulated while the distributee

corporation is a shareholder of the distributing corporation.

Generally, a corporate shareholder's ability to create an artificial

loss is reduced if all of the distributing corporation's earnings and

profits are accumulated while the distributee corporation is a

shareholder of the distributing corporation.

Section 1059(e)(1) expands the scope of the extraordinary dividend

definition in section 1059(c) by disregarding the holding period and

threshold rules for certain distributions. Generally, section

1059(e)(1) provides that a non pro rata redemption or a partial

liquidation that is treated as a dividend under section 301 is an

extraordinary dividend to which section 1059(a) applies without regard

to the threshold percentage or the period the taxpayer held such stock.

See General Explanation of the Tax Reform Act of 1986, Joint Committee

on Taxation, 100th Cong., 1st Sess. (May 4, 1987).

These regulations address the question of whether section

1059(d)(6) or (e)(2) applies to a distribution otherwise treated as an

extraordinary dividend under section 1059(e)(1). The IRS and Treasury

Department believe that applying those provisions to section 1059(e)(1)

is inconsistent with the purpose of section 1059 and may create

inappropriate consequences, such as basis shifting that eliminates gain

or creates an artificial loss.

Accordingly, these regulations clarify that neither section

1059(d)(6) nor section 1059(e)(2) applies to a distribution treated as

an extraordinary dividend under section 1059(e)(1). In finalizing these

regulations, the IRS and Treasury Department will consider comments

that illustrate distributions described in section 1059(e)(1) to which

the application of section 1059(d)(6) or (e)(2) is appropriate or to

which section 1059(e)(1) otherwise should not apply.

These regulations also address the question of whether an exchange

treated as a dividend under section 356(a)(2) is subject to section

1059(e)(1). These regulations clarify that for purposes of section

1059(e)(1), an exchange under section 356(a)(1) is treated as a

redemption and, to the extent any amount is treated as a dividend under

section 356(a)(2), it is treated as a dividend under section 301.

Explanation of Provisions

Proposed Sec. 1.1059(e)-1(a) provides that neither section

1059(d)(6) nor section 1059(e)(2) will prevent any distribution treated

as an extraordinary dividend under section 1059(e)(1) from being

treated as an extraordinary dividend. For example, if a redemption of

stock is not pro rata as to all shareholders, any amount treated as a

dividend under section 301 is treated as an extraordinary dividend

regardless of whether the dividend is a qualifying dividend.

Proposed Sec. 1.1059(e)-1(b) provides that for purposes of section

1059(e)(1), an exchange under section 356(a)(1) is treated as a

redemption and, to the extent any amount is treated as a dividend under

section 356(a)(2), it is treated as a dividend under section 301.

[[Page 30846]]

Proposed Effective Date

These regulations are proposed to apply to distributions announced

on or after June 17, 1996.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

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

chapter 5) 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, this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the IRS. All

comments will be available for public inspection and copying.

A public hearing has been scheduled at 10 a.m. on Wednesday,

October 2, 1996, room 3313, Internal Revenue Service, 1111 Constitution

Avenue NW., Washington, DC. Because of access restrictions, visitors

will not be admitted beyond the Internal Revenue Building lobby more

that 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must

submit written comments by September 16, 1996, and submit an outline of

the topics to be discussed and the time to be devoted to each topic

(signed original and eight (8) copies) by September 16, 1996.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information. The principal author of these regulations

is Richard K. Passales, Office of Assistant Chief Counsel

(Corporate), IRS. However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.1059(e)-1 also issued

under 26 U.S.C. 1059(e)(1) and (e)(2). * * *

Par. 2. Section 1.1059(e)-1 is added to read as follows:

Sec. 1.1059(e)-1 Non pro rata redemptions.

(a) In general. Section 1059(d)(6) (exception where stock held

during entire existence of corporation) and section 1059(e)(2)

(qualifying dividends) do not apply to a distribution treated as an

extraordinary dividend under section 1059(e)(1). For example, if a

redemption of stock is not pro rata as to all shareholders, any amount

treated as a dividend under section 301 is treated as an extraordinary

dividend regardless of whether the dividend is a qualifying dividend.

(b) Reorganizations. For purposes of section 1059(e)(1), an

exchange under section 356(a)(1) is treated as a redemption and, to the

extent any amount is treated as a dividend under section 356(a)(2), it

is treated as a dividend under section 301.

(c) Effective date. This section applies to distributions announced

(within the meaning of section 1059(d)(5)) on or after June 17, 1996.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 96-15454 Filed 6-17-96; 8:45 am]

BILLING CODE 4830-01-P