[Federal Register Volume 65, Number 191 (Monday, October 2, 2000)]
[Rules and Regulations]
[Pages 58650-58652]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-25258]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8904]
RIN 1545-AX38


Treatment of Nonqualified Preferred Stock and Other Preferred 
Stock in Certain Exchanges and Distributions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to 
nonqualified preferred stock. The 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 corporate reorganizations and 
distributions. The regulations are necessary to reflect changes to the 
law concerning these types of preferred stock that were made by the 
Taxpayer Relief Act of 1997.

EFFECTIVE DATE: These regulations are effective October 2, 2000.

FOR FURTHER INFORMATION CONTACT: Richard E. Coss, (202) 622-7790 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    On January 26, 2000, the IRS and Treasury published in the Federal 
Register a notice of proposed rulemaking (REG-105089-99, 2000-6 I.R.B. 
580 [65 FR 4203]) relating to nonqualified preferred stock (as defined 
in section 351(g)(2) of the Internal Revenue Code) (NQPS). The proposed 
regulations address the effective date of the definition of NQPS, and 
provide rules exempting from treatment as NQPS certain preferred stock 
received by shareholders in corporate reorganizations and distributions 
subject to sections 354, 355, and 356.
    No comments responding to the notice of proposed rulemaking were 
submitted, and no public hearing was requested or held. However, one 
commentator suggested that the rule in the proposed regulations 
interpreting section 351(g)(2)(C)(i)(II) (relating to preferred stock 
transferred in connection with the performance of services) should be 
expanded to include transactions subject to section 351.
    The IRS and Treasury agree with this suggestion. Accordingly, these 
final regulations extend the exemption from treatment as NQPS in 
Sec. 1.356-7(c) to preferred stock received by shareholders in certain 
stock exchanges under section 351. The proposed regulations are adopted 
as revised by this Treasury decision.

Special Analyses

    It has been determined that this Treasury decision 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 Procedure 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, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Richard E. Coss of the 
Office of Associate 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
the following entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.351-2 also issued under 26 U.S.C. 351(g)(4).
    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 1.351-2 is amended by adding paragraph (e) to read 
as follows:


Sec. 1.351-2  Receipt of property.

* * * * *
    (e) See Sec. 1.356-7(a) for the applicability of the definition of

[[Page 58651]]

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)(2) of the 
Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 921). 
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 1.354-1 is amended by adding paragraph (f) to read 
as follows:


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

* * * * *
    (f) 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. 4. Section 1.355-1 is amended by adding paragraph (d) to read 
as follows:


Sec. 1.355-1  Distribution 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. 5. 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). For purposes of this section, preferred stock that is not NQPS is 
referred to as Qualified Preferred Stock (QPS).
    (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 QPS, 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 QPS, provided--
    (i) The original preferred stock is QPS solely because, on its 
issue date, either 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, or 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 that, in 
relation to any term or terms of the original preferred stock, either 
decrease the period in which a right or obligation described in clause 
(i), (ii), or (iii) of section 351(g)(2)(A) can be exercised, or 
increase the likelihood that such a right or obligation will 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
    (ii) 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 
351(g)(1), 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. 1.356-6, the 
principles of paragraphs (a), (b), and (c) of this section apply.
    (e) Examples. In the examples in this paragraph (e), T and P are 
corporations, A is a shareholder of T, and A surrenders and receives 
(in addition to the stock exchanged in the examples) common stock in 
the reorganizations described. The following examples illustrate 
paragraphs (a), (b), and (c) of this section:

    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

[[Page 58652]]

redemption did not become more likely than 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 that 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 October 2, 2000.

    Par. 6. Section 1.1036-1 is amended by adding paragraph (d) to read 
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)(2) of the Taxpayer Relief Act of 1997, Public Law 
105-34 (111 Stat. 788, 921).

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.

    Approved: September 25, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 00-25258 Filed 9-29-00; 8:45 am]
BILLING CODE 4830-01-U