[Federal Register Volume 61, Number 118 (Tuesday, June 18, 1996)]
[Proposed Rules]
[Pages 30844-30846]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-15454]



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[[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