[Federal Register Volume 65, Number 17 (Wednesday, January 26, 2000)]
[Proposed Rules]
[Pages 4203-4207]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1529]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105089-99]
RIN 1545-AX38


Guidance Under Section 356 Relating to the Treatment of 
Nonqualified Preferred Stock and Other Preferred Stock in Certain 
Exchanges and Distributions

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 providing 
guidance relating to nonqualified preferred stock. The proposed 
regulations address the effective date of the definition of 
nonqualified preferred stock and the treatment of nonqualified 
preferred stock and similar preferred stock received by shareholders in 
certain reorganizations and distributions. This document also provides 
notice of a public hearing on these proposed regulations.

DATES:  Written or electronic comments and requests to speak (with 
outlines of oral comments) at a public hearing scheduled for 10 a.m., 
May 31, 2000, must be received by May 10, 2000.

ADDRESSES:  Send submissions to: CC:DOM:CORP:R (REG-105089-99), Room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-
105089-99), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
comments electronically via the Internet by selecting the ``Tax Regs'' 
option on the IRS Home Page or by submitting comments directly to the 
IRS Internet site at http://www.irs.ustreas.gov/tax__regs/
regslist.html. The public hearing will be held in the NYU Classroom, 
Room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT:  Concerning the proposed regulations, 
Richard E. Coss, (202) 622-7790; concerning submissions of comments, 
the hearing, and/or to be placed on the building access list to attend 
the hearing, LaNita Van Dyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under sections 354, 355, 356, and 1036 of 
the Internal Revenue Code (the Code). Section 1014 of the Taxpayer 
Relief Act of 1997 (TRA of 1997), Public Law 105-34, enacted on August 
5, 1997, amended sections 351, 354, 355, 356, and 1036 of the Code. As 
amended, these sections, in general, provide that nonqualified 
preferred stock (as defined in section 351(g)(2)) (NQPS) received in an 
exchange or distribution will not be treated as stock or securities 
but, instead, will be treated as ``other property'' or ``boot.'' As a 
result, the receipt of NQPS in a transaction occurring after the NQPS 
provisions are effective will, unless a specified exception applies, 
result in gain (or, in some instances, loss) recognition. Section 
351(g)(4) provides authority to issue regulations to carry out the 
purposes of these provisions.
    Section 351(g)(2)(A) defines NQPS as preferred stock if (1) the 
holder has the right to require the issuer or a related person to 
redeem or purchase the stock, (2) the issuer or a related person is 
required to redeem or purchase the stock, (3) the issuer or a related 
person has the right to redeem or purchase the stock and, as of the 
issue date, it is more likely than not that such right will be 
exercised, or (4) the dividend rate on the stock varies in whole or in 
part (directly or indirectly) with reference to interest rates, 
commodity prices, or other similar indices. Factors (1), (2), and (3) 
above will cause an instrument to be NQPS only if the right or 
obligation may be exercised within 20 years of the date the instrument 
is issued and such right or obligation is not subject to a contingency 
which, as of the issue date, makes remote the likelihood of the 
redemption or purchase.
    These rights or obligations do not cause preferred stock to be NQPS 
in certain circumstances described in section 351(g)(2)(C). In one such

[[Page 4204]]

exception, contained in section 351(g)(2)(C)(i)(II), a redemption or 
purchase right shall not cause stock to be NQPS if the stock containing 
the right is transferred in connection with the performance of services 
for the issuer or a related person (and represents reasonable 
compensation), and the right may be exercised only upon the holder's 
separation from service.
    The NQPS provisions also provide certain exceptions to the 
treatment of NQPS as boot. Under sections 354(a)(2)(C), 355(a)(3)(D), 
and 356(e)(2), NQPS is treated as stock, and not other property, in 
cases where the NQPS is received in exchange for, or in a distribution 
with respect to, NQPS. As a result, the receipt of NQPS in exchange for 
NQPS will not result in gain or loss recognition.
    Under prior law, preferred stock generally did not constitute boot 
in a reorganization or in a distribution under section 355 of the Code. 
The legislative history of the NQPS provisions indicates that Congress 
was concerned about nonrecognition transactions in which a secure 
preferred stock instrument is received in exchange for common stock or 
riskier preferred stock. The committee reports state that ``[c]ertain 
preferred stocks have been widely used in corporate transactions to 
afford taxpayers non-recognition treatment, even though the taxpayers 
may receive relatively secure instruments in exchange for relatively 
risky investments,'' and that ``[t]he Committee believes that when such 
preferred stock instruments are received in certain transactions, it is 
appropriate to view such instruments as taxable consideration, since 
the investor has often obtained a more secure form of investment.'' 
H.R. Rep. No. 148, 105th Cong., 1st Sess. 472 (1997); S. Rep. 33, 105th 
Cong., 1st Sess. (1997).
    The NQPS provisions apply to transactions after June 8, 1997, but 
will not apply to any transaction (1) made pursuant to a written 
agreement which was binding on such date and at all times thereafter, 
(2) described in a ruling request submitted to the IRS on or before 
such date, or (3) described in a public announcement or filing with the 
Securities and Exchange Commission on or before such date. Section 
1014(f) of TRA of 1997.
    A temporary regulation published as T.D. 8753 in the Federal 
Register on January 6, 1998, provides that, notwithstanding 
contemporaneously issued final regulations treating certain rights to 
acquire stock as securities that can be received tax-free in 
reorganizations and section 355 distributions, a right to acquire NQPS 
received in exchange for stock other than NQPS (or for a right to 
acquire stock other than NQPS) will not be treated as a security, and 
that NQPS received in exchange for stock other than NQPS (or for a 
right to acquire stock other than NQPS) will not be treated as stock or 
a security. The temporary regulation added Sec. 1.356-6T, and applies 
to NQPS (or a right to acquire such stock) received in connection with 
a transaction occurring on or after March 9, 1998 (other than 
transactions described in section 1014(f)(2) of TRA of 1997).

Explanation of Provisions

    The proposed regulations address three technical issues relating to 
the question of whether certain preferred stock instruments qualify as 
NQPS.
    The first issue addressed by the proposed regulations is whether 
stock described in section 351(g)(2) that was issued in a transaction 
on or before June 8, 1997, qualifies as NQPS (even though the receipt 
of such stock would not have been boot because the transaction in which 
it was received occurred prior to the NQPS provisions' effective date). 
Although the NQPS provisions generally are effective with respect to 
transactions occurring after June 8, 1997, neither the effective date 
provisions of section 1014(f) of TRA of 1997 nor the legislative 
history of the NQPS provisions addresses this issue.
    The proposed regulations provide that stock described in section 
351(g)(2) is NQPS regardless of the date on which the stock is issued. 
The IRS and Treasury believe that this represents the proper 
interpretation of the NQPS provisions; a contrary interpretation would 
give rise to results that are inconsistent with other NQPS provisions 
and their underlying policy.
    For example, assume that corporation (T) issues preferred stock 
described in section 351(g)(2) to shareholder (X) in 1996, and that X 
surrenders the T stock and receives NQPS of acquiring corporation (P) 
in a reorganization occurring after June 8, 1997 (when the NQPS 
provisions are effective). If the T preferred stock received in 1996 is 
not NQPS, X will recognize gain (if any) on the exchange. This result 
is unwarranted, because X is not receiving a more secure type of 
investment for a relatively risky type of investment, and exchanges of 
NQPS for NQPS are otherwise governed by the nonrecognition rules of 
sections 354, 355, and 356.
    The second issue addressed by the proposed regulations is the 
treatment of NQPS received in a reorganization in exchange for (or in a 
distribution with respect to) preferred stock that is not NQPS solely 
because, at the time the original stock was issued, a redemption or 
purchase right was not exercisable until after a 20-year period 
beginning on the issue date, or a redemption or purchase right was 
exercisable within a 20-year period but was subject to a contingency 
which made remote the likelihood of the redemption or purchase, or, in 
the case of an issuer's right to redeem or purchase stock described in 
section 351(g)(2)(A)(iii), was unlikely to be exercised within a 20-
year period beginning on the issue date (or because of any combination 
of these reasons). To illustrate, assume that after June 8, 1997, T 
issues preferred stock to X that permits the holder to require T to 
redeem the stock on demand, but not before the stock is held for 22 
years. Assume that seven years later, the T stock is exchanged in a 
reorganization for P preferred stock with substantially identical terms 
that permits the holder to require P to redeem the stock after 15 
years.
    Technically, this transaction could be viewed as a taxable exchange 
because X is receiving P stock that meets the definition of NQPS in 
exchange for T stock that is not NQPS (QPS). However, the IRS and 
Treasury believe that nonrecognition treatment is appropriate because 
the P stock represents a continuation of the original investment in the 
T stock.
    The proposed regulations provide a rule that treats the P stock 
received in such transactions as QPS if the P stock is substantially 
identical to the T preferred stock surrendered (or the T stock on which 
a distribution is made). The substantially identical requirement is 
necessary to ensure that this rule does not permit the NQPS provisions 
to be circumvented through exchanges of QPS for more secure NQPS. The P 
stock is considered to be substantially identical to the T stock if two 
conditions are met. The first condition is that the P stock does not 
contain any terms which, in relation to the terms of the T stock, 
decrease the period in which a redemption or purchase right will be 
exercised, increase the likelihood that such a right will be exercised, 
or accelerate the timing of the returns from the stock instrument 
(including the receipt of dividends or other distributions). The second 
condition is that, as a result of the receipt of P stock in the 
transaction, the exercise of the right or obligation does not become 
more likely than not to occur within a 20-year period beginning on the 
issue date of the T stock. To illustrate the two conditions, if the P 
stock contains a

[[Page 4205]]

term that permits the stock to be redeemed before the date on which the 
T stock could be redeemed, or if, at the time of the transaction, the T 
stock is not more likely than not to be redeemed within a 20-year 
period beginning on the issue date of the T stock but the P stock is 
more likely than not to be redeemed within a 20-year period beginning 
on the issue date of the T stock, the P stock is not substantially 
identical to the T stock.
    Under this rule, the P stock received will continue to be treated 
as QPS in subsequent transactions, and similar principles will apply to 
those transactions. For example, if the P stock is later exchanged in a 
reorganization for substantially identical stock of another acquiring 
corporation, the acquiring corporation stock will also be treated as 
QPS. However, if the P stock is later exchanged for stock described in 
section 351(g)(2) that is not substantially identical, the receipt of 
the stock will be treated as boot.
    The third issue addressed by the proposed regulations is how to 
interpret the provision that exempts from the definition of NQPS 
certain preferred stock containing a purchase or redemption right that 
may only be exercised on the holder's separation from service 
(compensation stock). To be exempted from the definition of NQPS under 
this provision, stock must be ``transferred in connection with the 
performance of services'' and must represent ``reasonable 
compensation.'' A commentator has questioned how these requirements 
apply in the context of a reorganization or distribution. The concern 
is that, when an employee of T receives P preferred stock in a 
reorganization in exchange for T stock of equal value, the P stock 
received could be considered transferred in exchange for stock (rather 
than for services), or could be considered not to represent reasonable 
compensation (because the P stock received in the equal value exchange 
represents no additional compensation to the employee). The legislative 
history of the NQPS provisions does not address these ambiguities.
    The IRS and Treasury believe that the exemption for compensation 
stock is intended to apply in situations where an employee previously 
received compensation stock and then surrenders that stock in a 
reorganization in exchange for new compensation stock containing a 
similar purchase or redemption right that can only be exercised upon 
separation from service. The proposed regulations provide a rule that 
treats the P preferred stock received in such transactions as 
satisfying the ``transferred in connection with the performance of 
services'' and the ``reasonable compensation'' requirements if the T 
stock surrendered (or the T stock on which a distribution is made) was 
originally transferred to the T employee in connection with the 
performance of services and represented reasonable compensation at the 
time of the transfer. This rule applies regardless of whether the T 
stock is common or preferred stock. No inference is intended regarding 
the meaning of the phrases ``transferred in connection with the 
performance of services'' and ``reasonable compensation'' for purposes 
other than the exemption from the definition of NQPS in section 
351(g)(2)(C)(i)(II).
    The proposed regulations also provide that the principles of the 
rules described above apply to transactions involving rights to acquire 
NQPS that are subject to Sec. 1.356-6T.

Proposed Effective Date

    The proposed regulations are proposed to be effective for 
transactions on the date that final regulations are published in the 
Federal Register. Notwithstanding the prospective effective date of the 
proposed regulations, the IRS and Treasury believe that the regulations 
prescribe the proper treatment of the transactions they address, and 
the IRS generally will not challenge return positions consistent with 
the regulations. However, a transaction involving rights to acquire 
NQPS that occurs before the effective date of Sec. 1.356-6T will be 
treated in accordance with the law governing rights to acquire stock in 
effect at that time.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedures 
Act (5 U.S.C. chapter 5) does not apply to these regulations and, 
because the regulations do not impose a collection of information on 
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
does not apply. Pursuant to section 7805(f) of the Internal Revenue 
Code, 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 (preferably a 
signed original and eight (8) copies, if written) that are submitted 
timely (in the manner described in the ADDRESSES portion of this 
preamble) to the IRS. The IRS and Treasury specifically request 
comments on the clarity of the proposed regulations and how the 
regulations may be made easier to understand. All comments will be 
available for public inspection and copying.
    A public hearing has been scheduled for May 31, 2000, beginning at 
10 a.m., in the NYU Classroom, Room 2615, Internal Revenue Building, 
1111 Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the 10th Street entrance, located 
between Constitution and Pennsylvania Avenues, NW. In addition, all 
visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the hearing 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must request to speak, and 
submit written comments and an outline of the topics to be discussed 
and the time to be devoted to each topic (signed original and eight (8) 
copies) by May 10, 2000. 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 proposed regulations is Richard E. 
Coss, Office of Assistant Chief Counsel (Corporate). However, other 
personnel from the IRS and Treasury 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 
the

[[Page 4206]]

following entries in numerical order to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *
    Section 1.354-1 also issued under 26 U.S.C. 351(g)(4).
    Section 1.355-1 also issued under 26 U.S.C. 351(g)(4). * * *
    Section 1.356-7 also issued under 26 U.S.C. 351(g)(4). * * *
    Section 1.1036-1 also issued under 26 U.S.C. 351(g)(4). * * *

    Par. 2. Section 1.354-1 is amended by adding paragraph (f) as 
follows:


Sec. 1.354-1  Exchanges of stock and securities in certain 
reorganizations.

* * * * *
    (f) Nonqualified preferred stock. See Sec. 1.356-7(a) and (b) for 
the treatment of nonqualified preferred stock (as defined in section 
351(g)(2)) received in certain exchanges for nonqualified preferred 
stock or preferred stock. See Sec. 1.356-7(c) for the treatment of 
preferred stock received in certain exchanges for common or preferred 
stock described in section 351(g)(2)(C)(i)(II).
    Par. 3. Section 1.355-1 is amended by adding paragraph (d) as 
follows:


Sec. 1.355-1  Distributions of stock and securities of a controlled 
corporation.

* * * * *
    (d) Nonqualified preferred stock. See Sec. 1.356-7(a) and (b) for 
the treatment of nonqualified preferred stock (as defined in section 
351(g)(2)) received in certain exchanges for (or in certain 
distributions with respect to) nonqualified preferred stock or 
preferred stock. See Sec. 1.356-7(c) for the treatment of the receipt 
of preferred stock in certain exchanges for (or in certain 
distributions with respect to) common or preferred stock described in 
section 351(g)(2)(C)(i)(II).
    Par. 4. Section 1.356-7 is added to read as follows:


Sec. 1.356-7  Rules for treatment of nonqualified preferred stock and 
other preferred stock received in certain transactions.

    (a) Stock issued prior to effective date. Stock described in 
section 351(g)(2) is nonqualified preferred stock (NQPS) regardless of 
the date on which the stock is issued. However, sections 351(g), 
354(a)(2)(C), 355(a)(3)(D), 356(e), and 1036(b) do not apply to any 
transaction occurring prior to June 9, 1997, or to any transaction 
occurring after June 8, 1997, that is described in section 1014(f)(2) 
of the Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 788, 
921.
    (b) Receipt of preferred stock in exchange for (or distribution on) 
substantially identical preferred stock (1) General rule. For purposes 
of sections 354(a)(2)(C)(i), 355(a)(3)(D), and 356(e)(2), preferred 
stock is not NQPS, even though it is described in section 351(g)(2), if 
it is received in exchange for (or in a distribution with respect to) 
preferred stock (the original preferred stock) that is not NQPS (QPS), 
provided--
    (i) The original preferred stock is QPS solely because, on its 
issue date, a right or obligation described in clause (i), (ii), or 
(iii) of section 351(g)(2)(A) was not exercisable until after a 20-year 
period beginning on the issue date, the right or obligation was 
exercisable within the 20-year period beginning on the issue date but 
was subject to a contingency which made remote the likelihood of the 
redemption or purchase, or the issuer's (or a related party's) right to 
redeem or purchase the stock was not more likely than not to be 
exercised within a 20-year period beginning on the issue date, or 
because of any combination of these reasons; and
    (ii) the stock received is substantially identical to the original 
preferred stock.
    (2) Substantially identical. The stock received is substantially 
identical to the original preferred stock if--
    (i) the stock received does not contain any term or terms which, in 
relation to any term or terms of the original preferred stock, decrease 
the period in which a right or obligation described in clause (i), 
(ii), or (iii) of section 351(g)(2)(A) may be exercised, increase the 
likelihood that such a right or obligation may be exercised, or 
accelerate the timing of the returns from the stock instrument, 
including the timing of actual or deemed dividends or other 
distributions received on the stock; and
    (B) as a result of the exchange or distribution, exercise of the 
right or obligation does not become more likely than not to occur 
within a 20-year period beginning on the issue date of the original 
preferred stock.
    (3) Treatment of stock received. The stock received will continue 
to be treated as QPS in subsequent transactions involving such stock, 
and the principles of this paragraph (b) apply to such transactions as 
though the stock received is the original preferred stock issued on the 
same date as the original preferred stock.
    (c) Stock transferred for services. For purposes of sections 
354(a)(2)(C)(i), 355(a)(3)(D), and 356(e)(2), preferred stock 
containing a right or obligation described in clause (i), (ii) or (iii) 
of section 351(g)(2)(A) that is exercisable only upon the holder's 
separation from service from the issuer or a related person (as 
described in section 351(g)(3)(B)) will be treated as transferred in 
connection with the performance of services (and representing 
reasonable compensation) within the meaning of section 
351(g)(2)(C)(i)(II), if such preferred stock is received in exchange 
for (or in a distribution with respect to) existing stock containing a 
similar right or obligation (exercisable only upon separation from 
service) and the existing stock was transferred in connection with the 
performance of services for the issuer or a related person (and 
represented reasonable compensation when transferred). In applying the 
rules relating to NQPS, the preferred stock received will continue to 
be treated as transferred in connection with the performance of 
services (and representing reasonable compensation) in subsequent 
transactions involving such stock, and the principles of this paragraph 
(c) apply to such transactions.
    (d) Rights to acquire stock. For purposes of Sec. 1.356-6T, the 
principles of paragraphs (a), (b), and (c) of this section apply.
    (e) Examples. The following examples illustrate paragraphs (a), 
(b), and (c) of this section. For purposes of the examples in this 
paragraph (e), T and P are corporations, A is a shareholder of T, and, 
except for in Example 1, A surrenders and receives (in addition to the 
stock exchanged in the examples) common stock in the reorganizations 
described.
    Example 1. In 1995, A transfers property to T and receives T 
preferred stock that is described in section 351(g)(2) in a 
transaction under section 351. In 2002, pursuant to a reorganization 
under section 368(a)(1)(B), A surrenders the T preferred stock in 
exchange for P NQPS. Under paragraph (a) of this section, the T 
preferred stock issued to A in 1995 is NQPS. However, because 
section 351(g) does not apply to transactions occurring before June 
9, 1997, the T NQPS was not ``other property'' within the meaning of 
section 351(b) when issued in 1995. Under sections 354(a)(2)(C) and 
356(e)(2), the P NQPS received by A in 2002 is not ``other 
property'' within the meaning of section 356(a)(1)(B) because it is 
received in exchange for NQPS.
    Example 2. T issues QPS to A on January 1, 2000 that is not NQPS 
solely because the holder cannot require T to redeem the stock until 
January 1, 2022. In 2007, pursuant to a reorganization under section 
368(a)(1)(A) in which T merges into P, A surrenders the T preferred 
stock in exchange for P preferred stock with terms that are 
identical to the terms of the T preferred stock, including the term 
that the holder cannot require the redemption of the stock until 
January 1, 2022. Because the P stock and the T stock have identical 
terms, and because the redemption did not become more likely than

[[Page 4207]]

not to occur within the 20-year period that begins on January 1, 
2000 (which is the issue date of the T preferred stock) as a result 
of the exchange, under paragraph (b) of this section, the P 
preferred stock received by A is treated as QPS. Thus, the P 
preferred stock received is not ``other property'' within the 
meaning of section 356(a)(1)(B).
    Example 3. The facts are the same as in Example 2, except that, 
in addition, in 2010, pursuant to a recapitalization of P under 
section 368(a)(1)(E), A exchanges the P preferred stock above for P 
NQPS that permits the holder to require P to redeem the stock in 
2020. Under paragraph (b) of this section, the P preferred stock 
surrendered by A is treated as QPS. Because the P preferred stock 
received by A in the recapitalization is not substantially identical 
to the P preferred stock surrendered, the P preferred stock received 
by A is not treated as QPS. Thus, the P preferred stock received is 
``other property'' within the meaning of section 356(a)(1)(B).
    Example 4. T issues preferred stock to A on January 1, 2000 that 
permits the holder to require T to redeem the stock on January 1, 
2018, or at any time thereafter, but which is not NQPS solely 
because, as of the issue date, the holder's right to redeem is 
subject to a contingency which makes remote the likelihood of 
redemption on or before January 1, 2020. In 2007, pursuant to a 
reorganization under section 368(a)(1)(A) in which T merges into P, 
A surrenders the T preferred stock in exchange for P preferred stock 
with terms that are identical to the terms of the T preferred stock. 
Immediately before the exchange, the contingency to which the 
holder's right to cause redemption of the T stock is subject makes 
remote the likelihood of redemption before January 1, 2020, but the 
P stock, although subject to the same contingency, is more likely 
than not to be redeemed before January 1, 2020. Because, as a result 
of the exchange of T stock for P stock, the exercise of the 
redemption right became more likely than not to occur within the 20-
year period beginning on the issue date of the T preferred stock, 
the P preferred stock received by A is not substantially identical 
to the T stock surrendered, and is not treated as QPS. Thus, the P 
preferred stock received is ``other property'' within the meaning of 
section 356(a)(1)(B).
    Example 5. The facts are the same as in Example 4, except that, 
immediately before the merger of T into P in 2007, the contingency 
to which the holder's right to cause redemption of the T stock is 
subject makes it more likely than not that the T stock will be 
redeemed before January 1, 2020. Because exercise of the redemption 
right did not become more likely than not to occur within the 20-
year period beginning on the issue date of the T preferred stock as 
a result of the exchange, the P preferred stock received by A is 
substantially identical to the T stock surrendered, and is treated 
as QPS. Thus, the P preferred stock received is not ``other 
property'' within the meaning of section 356(a)(1)(B).
    Example 6. A is an employee of T. In connection with A's 
performance of services for T, T transfers to A in 2000 an amount of 
T common stock that represents reasonable compensation. The T common 
stock contains a term granting A the right to require T to redeem 
the common stock, but only upon A's separation from service from T. 
In 2005, pursuant to a reorganization under section 368(a)(1)(A) in 
which T merges into P, A receives, in exchange for A's T common 
stock, P preferred stock granting a similar redemption right upon 
A's separation from P's service. Under paragraph (c) of this 
section, the P preferred stock received by A is treated as 
transferred in connection with the performance of services (and 
representing reasonable compensation) within the meaning of section 
351(g)(2)(C)(i)(II). Thus, the P preferred stock received by A is 
QPS.

    (f) Effective dates. This section applies to transactions occurring 
on or after the date these regulations are published as final 
regulations in the Federal Register.
    Par. 5. Section 1.1036-1 is amended by adding paragraph (d) as 
follows:


Sec. 1.1036-1  Stock for stock of the same corporation.

* * * * *
    (d) Nonqualified preferred stock. See Sec. 1.356-7(a) for the 
applicability of the definition of nonqualified preferred stock in 
section 351(g)(2) for stock issued prior to June 9, 1997, and for stock 
issued in transactions occurring after June 8, 1997, that are described 
in section 1014(f) of the Taxpayer Relief Act of 1997, Public Law 105-
34, 111 Stat. 788,921.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-1529 Filed 1-21-00 11:59 am]
BILLING CODE 4380-01-U