[Federal Register Volume 68, Number 171 (Thursday, September 4, 2003)]
[Rules and Regulations]
[Pages 52487-52496]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-22453]


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DEPARTMENT OF TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9089]
RIN 1545-BC39


Guidance Under Section 1502; Application of Section 108 to 
Members of a Consolidated Group

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations under section 
1502 that govern the application of section 108 when a member of a 
consolidated group realizes discharge of indebtedness income. These 
temporary regulations affect corporations filing consolidated returns. 
The text of the temporary regulations also serves as the text of the 
proposed regulations set forth in the notice of proposed rulemaking on 
this subject in the Proposed Rules section in this issue of the Federal 
Register.

[[Page 52488]]


DATES: Effective Date: These regulations are effective August 29, 2003.

FOR FURTHER INFORMATION CONTACT: Amber Renee Cook or Marie C. Milnes-
Vasquez at (202) 622-7530 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 61(a)(12) of the Internal Revenue Code provides that gross 
income includes income from the discharge of indebtedness, except as 
provided by law. Section 108(a) provides that gross income of a C 
corporation does not include any amount that would otherwise be 
includible in gross income by reason of the discharge, in whole or in 
part, of indebtedness of the taxpayer if the discharge occurs in a 
title 11 case (section 108(a)(1)(A)), the discharge occurs when the 
taxpayer is insolvent, but only to the extent of the insolvency 
(section 108(a)(1)(B)), or the indebtedness discharged is qualified 
farm indebtedness (section 108(a)(1)(C)).
    Although section 108 does not require certain taxpayers to include 
discharge of indebtedness income in gross income, it does require the 
reduction of tax attributes. Section 108(b)(1) provides that if a 
taxpayer excludes an amount from gross income under section 
108(a)(1)(A), (B), or (C), the taxpayer must reduce its tax attributes 
by the amount excluded. Absent an election under section 108(b)(5) 
(described below), pursuant to section 108(b)(2), tax attributes are 
reduced in the following order: net operating losses and net operating 
loss carryovers, general business credits under section 38, minimum tax 
credits under section 53(b), net capital losses and capital loss 
carryovers, asset basis, passive activity loss and credit carryovers 
under section 469(b), and foreign tax credits and foreign tax credit 
carryovers. Section 108(b)(5) provides that the taxpayer may elect to 
apply any portion of excluded discharge of indebtedness income to first 
reduce basis in depreciable assets under the rules of section 1017. Any 
amount of debt discharge that remains after attribute reduction is not 
includible in income. See H.R. Rep. 96-833 at 11 (1980); S. Rep. No. 
96-1035 at 12 (1980).
    These provisions are designed to ``preserve the debtor's `fresh 
start' after bankruptcy.'' H.R. Rep. 96-833 at 9 (1980); see S. Rep. 
No. 96-1035 at 10 (1980). In addition, they are intended to ``carry out 
the Congressional intent of deferring, but eventually collecting within 
a reasonable period, tax on ordinary income realized from debt 
discharge.'' H.R. Rep. 96-833 at 9 (1980); see S. Rep. No. 96-1035 at 
10 (1980). By making attributes unavailable to offset income in later 
years, the provisions offer the debtor a temporary, rather than a 
permanent, deferral of tax.
    Questions have arisen regarding the application of section 108 when 
the taxpayer with discharge of indebtedness income that is excluded 
from gross income is a member of a consolidated group. In particular, 
questions have arisen regarding the determination of the attributes 
that are available for reduction in a consolidated group and the method 
for reducing those attributes. These regulations provide guidance 
regarding those questions.

Explanation of Provisions

A. Application of Section 108(a)(1)(B)

    As described above, pursuant to section 108(a)(1)(B), gross income 
of an insolvent C corporation does not include any amount that would 
otherwise be includible in gross income by reason of the discharge, in 
whole or in part, of indebtedness of the taxpayer, but only to the 
extent of the insolvency. The IRS and Treasury believe that computing 
the amount of the insolvency for purposes of section 108(a)(1)(B) with 
respect to only the debtor member reflects that, without an agreement 
that provides otherwise, the assets of members other than the debtor 
member will not be available to satisfy claims of the creditors of the 
debtor member. Therefore, these temporary regulations provide that the 
amount of discharge of indebtedness income excluded from gross income 
in the case in which the debtor is insolvent is determined based on the 
assets and liabilities of only the member with discharge of 
indebtedness income.

B. Application of Section 108(b)

1. Consolidated Approach
    The IRS and Treasury Department have considered a separate entity 
approach and various consolidated approaches to the application of the 
attribute reduction rules of section 108(b) in the consolidated group 
context. As explained below, these regulations adopt a consolidated 
approach that reduces all attributes that are available to the debtor.
    The IRS and Treasury Department have rejected a separate entity 
approach. Such an approach would reduce only the attributes 
attributable to the member with excluded discharge of indebtedness 
income. The IRS and Treasury Department have rejected this approach 
because it fails to take into account the fact that consolidated 
attributes that are attributable to other members will be available to 
offset income of the debtor member as long as the debtor is a member of 
the group. A separate entity approach could result in the permanent 
exclusion of discharge of indebtedness income when there are other 
attributes available to the debtor member.
    In the view of the IRS and Treasury Department, the policies 
underlying section 108 require a consolidated approach that reduces all 
attributes that are available to the debtor. An approach that does not 
reduce all of such attributes is inconsistent with Congressional intent 
that income realized from debt discharge generally be deferred and not 
permanently eliminated. Furthermore, reducing all of the consolidated 
attributes available to the debtor member reflects the principle 
enunciated by the Supreme Court in United Dominion Indus., Inc. v. 
United States, 532 U.S. 822 (2001), that, in general, the only net 
operating loss of a consolidated group or its members for a 
consolidated return year is the consolidated net operating loss. 
Consistent with United Dominion, the tax attributes subject to 
reduction under section 108(b) when the debtor is a member of a 
consolidated group include the group's consolidated attributes in their 
entirety. Therefore, these temporary regulations provide for the 
reduction of consolidated net operating losses and all other 
consolidated tax attributes, including consolidated tax attributes that 
are attributable to members other than the debtor member.
    When the debtor is a member of a consolidated group, consolidated 
tax attributes attributable to other members may be used to offset 
income of the debtor member. That ability may enable the debtor member 
to offset future income with the consolidated attributes attributable 
to other members. As a result, unless such other attributes are 
reduced, discharge of indebtedness income that is excluded from gross 
income may never result in taxable income.
    Unlike consolidated attributes, the basis of assets held by members 
other than the debtor member is not directly available to offset income 
of the debtor member. In fact, the basis of assets held by members 
other than the debtor member may never give rise to an attribute that 
could be directly available to offset income of a member of the group 
for a consolidated return year. Therefore, as explained below, these 
temporary regulations provide for a reduction of basis of assets of 
members other than the debtor member only in limited circumstances.

[[Page 52489]]

2. Ordering Rule
    Under these temporary regulations, the attributes attributable to 
the debtor member are first subject to reduction. For this purpose, 
attributes attributable to the debtor member include (1) consolidated 
attributes attributable to the debtor member, (2) attributes that arose 
in separate return limitation years of the debtor member, and (3) the 
basis of property of the debtor member. The amount of a consolidated 
attribute attributable to the debtor member is determined pursuant to 
the principles of Sec.  1.1502-21(b). To the extent that the excluded 
discharge of indebtedness income exceeds the attributes attributable to 
the debtor member, these temporary regulations require the reduction of 
consolidated attributes attributable to other members and attributes 
attributable to members other than the debtor member that arose (or are 
treated as arising) in a separate return limitation year to the extent 
that the debtor member is a member of the separate return limitation 
year subgroup with respect to such attribute.
    The availability of tax attributes attributable to other members of 
a consolidated group to reduce the future income of the debtor member 
creates the possibility of shifting the location of tax attributes and 
future tax liability. Preserving the location of tax items within the 
group is a fundamental policy underlying the consolidated return 
regulations which is reflected in a number of such regulations. See, 
e.g., Sec.  1.1502-13 (regarding intercompany transactions); Sec.  
1.1502-21 (regarding the use of attributes that arise in separate 
return limitation years). Location is particularly important when a 
member leaves the group and no longer shares the attributes 
attributable to it with, or uses the attributes attributable to, the 
other members. This sharing of tax attributes can shift the location of 
items within the group, affecting the amount of consolidated tax 
attributes that a member takes with it when it leaves the group.
    The IRS and Treasury Department did not adopt an alternative 
consolidated approach that would require the reduction of consolidated 
attributes attributable to other members prior to the reduction of all 
of the attributes attributable to the debtor member. Such an approach 
would not preserve the location of income in the debtor member 
resulting from the reduction of attributes as effectively as the 
approach adopted in these temporary regulations. For example, a 
reduction of the consolidated attributes attributable to each member 
before the reduction of all of the attributes attributable to the 
debtor member could cause a shifting of the tax burden if the debtor 
member subsequently leaves the group. In that case, the debtor member 
may take with it a larger portion of the consolidated attributes than 
it otherwise would, while a portion of the consolidated attributes 
attributable to other members would be reduced. The larger portion of 
the consolidated attributes that the debtor member would take with it 
would be available to offset future income of the debtor member, while 
the remaining members of the group would bear a higher tax burden as a 
result of the unavailability of those consolidated attributes.
    These temporary regulations achieve the dual objectives of 
subjecting the entire amount of consolidated attributes to reduction 
and preserving the location of future income that is deferred by first 
reducing attributes attributable to the debtor member, including 
consolidated attributes, in the order prescribed in section 108(b) and 
then reducing the remaining amount of consolidated attributes. This 
ordering rule reduces the potential to shift the location of attributes 
within the group.
3. Look-Through Rule
    The adopted approach include a look-through rule that applies if 
the attribute of the debtor member reduced is the basis of stock of 
another member of the group. In these cases, corresponding adjustments 
must be made to the attributes attributable to the lower-tier member. 
To effect those corresponding adjustments, these temporary regulations 
treat the lower-tier member as a debtor member that has discharge of 
indebtedness income that is excluded from gross income in the amount of 
the stock basis reduction for purposes of the rules relating to the 
reduction of the attributes attributable to a debtor member. For this 
purpose, the consolidated attributes attributable to the lower-tier 
member (determined pursuant to the principles of Sec.  1.1502-21(b)) as 
well as the lower-tier member's separate attributes (including 
attributes that arose in separate return limitation years and asset 
basis) are available for reduction. The look-through rule is consistent 
with the treatment of a group as a single taxpayer under a number of 
the consolidated return regulations, including the provisions allowing 
the consolidated tax attributes attributable to one member of a group 
to offset income of other members of the group and the investment 
adjustment rules that adjust the basis of subsidiary stock to reflect 
the income and absorbed losses of the subsidiary.

C. Corresponding Amendments

    Included in these temporary regulations are amendments to certain 
provisions of the consolidated return regulations that reflect the 
attribute reduction rules that apply when the debtor is a member of a 
consolidated group. The following paragraphs describe these amendments.
1. The Investment Adjustment Rules
    Under Sec.  1.1502-32(b)(3)(ii)(C), discharge of indebtedness 
income of a subsidiary that is excluded from gross income is treated as 
tax-exempt income for purposes of the investment adjustment rules only 
to the extent it is applied to reduce attributes. For this purpose, a 
discharge of indebtedness is treated as applied to reduce tax 
attributes only to the extent the attribute reduction is taken into 
account as a noncapital, nondeductible expense under Sec.  1.1502-32. 
The investment adjustment rules of Sec.  1.1502-32 do not apply to 
affect the basis of the stock of the common parent of a group. 
Therefore, to the extent that discharge of indebtedness income reduces 
consolidated attributes that are attributable to the common parent, no 
positive basis adjustment is made to the stock of the subsidiary. 
Furthermore, because the reduction of a tax credit is not a noncapital, 
nondeductible expense, to the extent that the discharge of indebtedness 
income reduces a tax credit, no positive basis adjustment is made to 
the stock of the subsidiary.
    The IRS and Treasury Department believe that a positive basis 
adjustment should be made to the basis of the stock of a debtor 
subsidiary even if the discharge of indebtedness income reduces an 
attribute that is attributable to the common parent. This position is 
consistent with the approach of Sec.  1.1502-32 that income of a 
subsidiary that is offset by net operating losses generated by the 
common parent results in an increase in the basis of the subsidiary 
stock. In addition, the IRS and Treasury Department believe that a 
positive basis adjustment should be made to the basis of the stock of a 
debtor subsidiary even if the discharge of indebtedness income reduces 
a credit of any member. Accordingly, these temporary regulations treat 
as tax-exempt income discharge of indebtedness income that is excluded 
from gross income to the extent that such excluded income reduces tax 
attributes, including tax attributes attributable to the common parent 
and any other attribute the reduction of which is not treated as a 
noncapital, nondeductible expense, such as a credit.

[[Page 52490]]

2. The Excess Loss Account Rules
    Under Sec.  1.1502-19, an excess loss account attributable to 
subsidiary stock must be included in income when an indebtedness of 
that subsidiary is discharged and 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. This rule may require inclusion of an excess 
loss account in income in an amount that is substantially greater than 
the amount discharged that is not treated as tax-exempt income.
    The IRS and Treasury Department believe that requiring the 
inclusion of the excess loss account in income only to the extent of 
the amount discharged that is not treated as tax-exempt income is 
consistent with the policies underlying section 108 and the 
consolidated return regulations. Accordingly, these temporary 
regulations modify the rules of Sec.  1.1502-19 to provide that the 
excess loss account must be included in income only to the extent that 
any amount discharged that is excluded from gross income is not treated 
as tax-exempt income.
3. Rules Governing Apportionment of Net Operating Losses
    The temporary regulations also include modifications to the rules 
of Sec.  1.1502-21 relating to the amount of consolidated net operating 
losses apportioned to a subsidiary when a consolidated net operating 
loss is absorbed and when a subsidiary departs from the group. These 
modifications take into account the reduction of the net operating 
losses attributable to that member that occurs as a result of discharge 
of indebtedness.

D. Request for Comments

    The IRS and Treasury Department are considering adopting rules 
under section 1502 (and possibly other Code sections) to address the 
effect of transitory transactions and other transactions designed to 
avoid the application of the rules concerning attribute reduction. 
Comments are requested regarding whether such a rule should be adopted 
and the appropriate scope of such a rule. Even in the absence of such a 
rule, such transactions may be challenged under existing law. If the 
IRS and Treasury Department determine such a rule is necessary to 
protect the policies underlying section 108 and the consolidated return 
regulations, the IRS and Treasury Department are prepared to promulgate 
such a rule with retroactive effect to discharges of indebtedness that 
occur after August 29, 2003.

Effective Dates

    The temporary regulations related to the application of section 
108(b) when a member of a consolidated group realizes discharge of 
indebtedness income that is excluded from gross income apply to 
discharges of indebtedness that occur after August 29, 2003. The 
amendments to the investment adjustment rules apply with respect to 
determinations of stock basis in consolidated return years the original 
return for which is due (without extensions) after August 29, 2003. The 
amendments to the excess loss account rules apply to dispositions of 
subsidiary stock after August 29, 2003. However, taxpayers may apply 
the amendments to the investment adjustment rules and the excess loss 
account rules retroactively. Finally, the amendments to the net 
operating loss rules apply only to taxable years the original return 
for which the due date (without extensions) is after August 29, 2003.

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. These temporary 
regulations are necessary to provide taxpayers with immediate guidance 
regarding the application of section 108 when a member of a 
consolidated group has discharge of indebtedness income that is 
excluded from gross income. Current circumstances have made the 
application of section 108 in the consolidated group context an issue 
that needs to be addressed at this time. In addition, consolidated 
groups may be taking positions that are inconsistent with the policies 
underlying section 108 and the principle enunciated by the Supreme 
Court in United Dominion Indus., Inc. v. United States, 532 U.S. 822 
(2001). Accordingly, good cause is found for dispensing with notice and 
public procedure pursuant to 5 U.S.C. 553(b)(B) and with a delayed 
effective date pursuant to 5 U.S.C. 553(d)(3). For applicability of the 
Regulatory Flexibility Act, please refer to the cross-reference notice 
of proposed rulemaking published elsewhere in this issue of the Federal 
Register. Pursuant to section 7805(f) of the Internal Revenue Code, 
these temporary regulations will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small business.

Drafting Information

    Various personnel from the IRS and Treasury Department participated 
in the development of the regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the two entries for Sec.  1.1502-32T and adding the following entries 
in numerical order to read in part as follows:

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

    Section 1.1502-19T also issued under 26 U.S.C. 1502. * * *
    Section 1.1502-28T also issued under 26 U.S.C. 1502. * * *
    Section 1.1502-32T also issued under 26 U.S.C. 1502. * * *


0
Par. 2. Section 1.1502-19 is amended as follows:
0
1. Paragraph (b)(1) is revised.
0
2. The headings for paragraphs (h)(2) and (h)(2)(i) are revised.
0
3. Paragraph (h)(2)(ii) is redesignated as paragraph (h)(2)(iii).
0
4. New paragraph (h)(2)(ii) is added.
    The revisions and addition read as follows:


Sec.  1.1502-19  Excess loss accounts.

* * * * *
    (b) * * * (1) [Reserved]. For further guidance, see Sec.  1.1502-
19T(b)(1).
* * * * *
    (h) * * *
    (2) Dispositions of stock--(i) Dispositions of stock before 
effective date. * * *
    (ii) Application of special limitation. [Reserved]. For further 
guidance, see Sec.  1.1502-19T(h)(2)(ii).
* * * * *
0
Par. 3. Section 1.1502-19T is added to read as follows:


Sec.  1.1502-19T  Excess loss accounts (temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.1502-19(a).
    (b) Excess loss account taken into account as income or gain--(1) 
Operating rules--(i) General rule. Except as provided in paragraph 
(b)(1)(ii) of this section, if P is treated under Sec.  1.1502-19 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.
    (ii) Special limitation on amount taken into account. 
Notwithstanding

[[Page 52491]]

paragraph (b)(1)(i) of this section, if P is treated as disposing of a 
share of S's stock as a result of the application of Sec.  1.1502-
19(c)(1)(iii)(B), the aggregate amount of its excess loss account in 
the shares of S's stock that P takes into account as income or gain 
from the disposition shall not exceed the amount of S's indebtedness 
that is discharged that is neither included in gross income nor treated 
as tax-exempt income under Sec.  1.1502-32T(b)(3)(ii)(C)(1). If more 
than one share of S's stock has an excess loss account, such excess 
loss accounts shall be taken into account pursuant to the preceding 
sentence, to the extent possible, in a manner that equalizes the excess 
loss accounts in S's shares that have an excess loss account.
    (iii) Treatment of disposition. Except as provided in Sec.  1.1502-
19(b)(4), the disposition is treated as a sale or exchange for purposes 
of determining the character of the income or gain.
    (b)(2) through (h)(2)(i) [Reserved]. For further guidance, see 
Sec.  1.1502-19(b)(2) through (h)(2)(i).
    (h)(2)(ii) Application of special limitation. If P was treated as 
disposing of stock of S because S was treated as worthless as a result 
of the application of Sec.  1.1502-19(c)(1)(iii)(B) after August 29, 
2003 and in a consolidated return year beginning on or after January 1, 
1995, the amount of P's income, gain, deduction, or loss, and the stock 
basis reflected in that amount, are determined or redetermined with 
regard to paragraph (b)(1)(ii) of this section. If P was treated as 
disposing of stock of S because S was treated as worthless as a result 
of the application of Sec.  1.1502-19(c)(1)(iii)(B) on or before August 
29, 2003 and in a consolidated return year beginning on or after 
January 1, 1995, the group may determine or redetermine the amount of 
P's income, gain, deduction, or loss, and the stock basis reflected in 
that amount with regard to paragraph (b)(1)(ii) of this section.
    (h)(2)(iii) through (h)(3) [Reserved]. For further guidance, see 
Sec.  1.1502-19(h)(2)(iii) through (h)(3).

0
Par. 4. Section 1.1502-21 is amended as follows:
0
1. Paragraphs (b)(2)(iv) and (c)(2)(vii) are revised.
0
2. Paragraphs (h)(6) and (h)(7) are redesignated as paragraphs (h)(7) 
and (h)(8).
0
3. New paragraph (h)(6) is added.
0
4. Newly designated paragraph (h)(8) is revised.
    The revision and additions read as follows:


Sec.  1.1502-21  Net operating losses.

* * * * *
    (b) * * *
    (2) * * *
    (iv) [Reserved]. For further guidance, see Sec.  1.1502-
21T(b)(2)(iv).
* * * * *
    (c) * * *
    (2) * * *
    (vii) [Reserved]. For further guidance, see Sec.  1.1502-
21T(c)(2)(vii).
* * * * *
    (h) * * *
    (6) [Reserved]. For further guidance, see Sec.  1.1502-21T(h)(6).
* * * * *
    (8) [Reserved]. For further guidance, see Sec.  1.1502-21T(h)(8).
0
Par. 5. Section 1.1502-21T is amended as follows:
0
1. Paragraphs (b)(1) through (b)(3)(ii)(B) are revised.
0
2. Paragraphs (c) through (h)(7) are revised.
0
3. Paragraph (h)(8) is added.
    The revisions and addition read as follows:


Sec.  1.1502-21T  Net operating losses (temporary).

* * * * *
    (b) * * * (1) Carryovers and carrybacks generally. The net 
operating loss carryovers and carrybacks to a taxable year are 
determined under the principles of section 172 and this section. Thus, 
losses permitted to be absorbed in a consolidated return year generally 
are absorbed in the order of the taxable years in which they arose, and 
losses carried from taxable years ending on the same date, and which 
are available to offset consolidated taxable income for the year, 
generally are absorbed on a pro rata basis. In addition, the amount of 
any CNOL absorbed by the group in any year is apportioned among members 
based on the percentage of the CNOL attributable to each member as of 
the beginning of the year. The percentage of the CNOL attributable to a 
member is determined pursuant to paragraph (b)(2)(iv)(B) of this 
section. Additional rules provided under the Internal Revenue Code or 
regulations also apply. See, e.g., section 382(l)(2)(B) (if losses are 
carried from the same taxable year, losses subject to limitation under 
section 382 are absorbed before losses that are not subject to 
limitation under section 382). See Sec.  1.1502-21(c)(1)(iii), Example 
2, for an illustration of pro rata absorption of losses subject to a 
SRLY limitation. See paragraph (b)(3)(v) of this section regarding the 
treatment of any loss that is treated as expired under Sec.  1.1502-
35T(f)(1).
    (2) (i) through (iii) [Reserved]. For further guidance, see Sec.  
1.1502-21(b)(2) (i) through (iii).
    (iv) Operating rules--(A) Amount of CNOL attributable to a member. 
The amount of a CNOL that is attributable to a member shall equal the 
product of the CNOL and the percentage of the CNOL attributable to such 
member.
    (B) Percentage of CNOL attributable to a member--(1) In general. 
Except as provided in paragraph (b)(2)(iv)(B)(2) of this section, the 
percentage of the CNOL attributable to a member shall equal the 
separate net operating loss of the member for the year of the loss 
divided by the sum of the separate net operating losses for that year 
of all members having such losses. For this purpose, the separate net 
operating loss of a member is determined by computing the CNOL by 
reference to only the member's items of income, gain, deduction, and 
loss, including the member's losses and deductions actually absorbed by 
the group in the taxable year (whether or not absorbed by the member).
    (2) Special rule. If during a taxable year either a member realizes 
discharge of indebtedness income that is excluded from gross income 
under section 108(a) and such amount reduces any portion of the CNOL 
attributable to such member pursuant to section 108 and Sec.  1.1502-
28T, or a member that had a separate net operating loss for the year of 
the CNOL ceases to be a member, the percentage of the CNOL attributable 
to each member as of the first day of the following taxable year shall 
be recomputed. In addition, if a portion of the CNOL attributable to a 
member for a taxable year is carried back to a separate return year, 
the percentage of the CNOL attributable to each member as of the first 
day of the taxable year following the taxable year of the CNOL shall be 
recomputed. In each case, such recomputed percentage shall equal the 
unabsorbed CNOL attributable to the member on the first day of the 
following taxable year divided by the sum of the unabsorbed CNOL 
attributable to all of the members on the first day of the following 
taxable year. For purposes of the preceding sentence, a CNOL that is 
reduced pursuant to section 108 and Sec.  1.1502-28T or that is 
otherwise permanently disallowed or eliminated shall be treated as 
absorbed.
    (b)(2)(v) through (b)(3)(ii)(B) [Reserved]. For further guidance, 
see Sec.  1.1502-21(b)(2)(v) through (b)(3)(ii)(B).
* * * * *
    (c)(1) through (c)(2)(vi) [Reserved]. For further guidance, see 
Sec.  1.1502-21(c)(1) through (c)(2)(vi).
    (vii) Corporations that leave a SRLY subgroup. If a loss member 
ceases to be affiliated with a SRLY subgroup, the amount of the 
member's remaining

[[Page 52492]]

SRLY loss from a specific year is determined pursuant to the principles 
of Sec.  1.1502-21(b)(2)(ii)(A) and Sec.  1.1502-21T(b)(2)(iv).
    (c)(2)(viii) through (h)(5) [Reserved]. For further guidance, see 
Sec.  1.1502-21(c)(2)(viii) through (h)(5).
    (6) Certain prior periods. Paragraphs (b)(1), (b)(2)(iv), and 
(c)(2)(vii) of this section shall only apply to taxable years the 
original return for which the due date (without extensions) is after 
August 29, 2003. For taxable years the original return for which the 
due date (without extensions) is on or before August 29, 2003, see 
paragraphs (b)(1), (b)(2)(iv), and (c)(2)(vii) of Sec.  1.1502-21 and 
paragraph (b)(1) of Sec.  1.1502-21T as contained in 26 CFR part 1 
revised April 1, 2003.
    (7) [Reserved]. For further guidance, see Sec.  1.1502-21(h)(7).
    (8) Losses treated as expired under Sec.  1.1502-35T(f)(1). 
Paragraph (b)(3)(v) of this section is effective for losses treated as 
expired under Sec.  1.1502-35T(f)(1) on and after March 7, 2002, and no 
later than March 11, 2006.

0
Par. 6. Section 1.1502-28T is added to read as follows:


Sec.  1.1502-28T  Consolidated section 108 (temporary).

    (a) In general. This section sets forth rules for the application 
of section 108(a) and the reduction of tax attributes pursuant to 
section 108(b) when a member of the group realizes discharge of 
indebtedness income that is excluded from gross income under section 
108(a) (excluded COD income).
    (1) Application of section 108(a). Section 108(a)(1)(B) is applied 
separately to each member that realizes excluded COD income. Therefore, 
the limitation of section 108(a)(3) on the amount of discharge of 
indebtedness income that is treated as excluded COD income is 
determined based on the assets (including stock and securities of other 
members) and liabilities (including liabilities to other members) of 
only the member that realizes excluded COD income.
    (2) Reduction of tax attributes attributable to the debtor--(i) In 
general. With respect to a member that realizes excluded COD income in 
a taxable year, the tax attributes attributable to that member (and its 
direct and indirect subsidiaries to the extent required by section 
1017(b)(3)(D) and paragraph (a)(3) of this section), including basis of 
assets and losses and credits arising in separate return limitation 
years, shall be reduced as provided in sections 108 and 1017 and this 
section. Basis of subsidiary stock, however, shall not be reduced below 
zero.
    (ii) Consolidated tax attributes attributable to a member. For 
purposes of this section, the amount of a consolidated tax attribute 
that is attributable to a member shall be determined pursuant to the 
principles of Sec.  1.1502-21T(b)(2)(iv). In addition, if the member is 
a member of a separate return limitation year subgroup, the amount of a 
tax attribute that arose in a separate return limitation year that is 
attributable to that member shall also be determined pursuant to the 
principles of Sec.  1.1502-21T(b)(2)(iv).
    (3) Look-through rules--(i) Priority of section 1017(b)(3)(D). If a 
member treats stock of a subsidiary as depreciable property pursuant to 
section 1017(b)(3)(D), the basis of the depreciable property of such 
subsidiary shall be reduced pursuant to section 1017(b)(3)(D) prior to 
the application of paragraph (a)(3)(ii) of this section.
    (ii) Application of additional look-through rule. If the basis of 
stock of a member (the lower-tier member) that is owned by another 
member is reduced pursuant to section 108, section 1017, and paragraph 
(a)(2) of this section (but not as a result of treating subsidiary 
stock as depreciable property pursuant to section 1017(b)(3)(D)), 
solely for purposes of sections 108 and 1017 and this section other 
than paragraphs (a)(4) and (b)(1) of this section, the lower-tier 
member shall be treated as realizing excluded COD income. The amount of 
such excluded COD income shall be the amount of such basis reduction. 
Accordingly, the tax attributes attributable to such lower-tier member 
shall be reduced as provided in sections 108 and 1017 and this section. 
To the extent that the excluded COD income realized by the lower-tier 
member pursuant to this paragraph (a)(3) does not reduce a tax 
attribute attributable to the lower-tier member, such excluded COD 
income shall not be applied to reduce tax attributes attributable to 
any member under paragraph (a)(4) of this section.
    (4) Reduction of certain tax attributes attributable to other 
members. To the extent that, pursuant to paragraph (a)(2) of this 
section, the excluded COD income is not applied to reduce the tax 
attributes attributable to the member that realizes the excluded COD 
income, after the application of paragraph (a)(3) of this section, such 
amount shall be applied to reduce the remaining consolidated tax 
attributes of the group as provided in section 108 and this section. 
Such amount also shall be applied to reduce the tax attributes 
attributable to members that arose (or are treated as arising) in a 
separate return limitation year to the extent that the member that 
realizes excluded COD income is a member of the separate return 
limitation year subgroup with respect to such attribute. The reduction 
of each tax attribute pursuant to the two preceding sentences shall be 
made in the order prescribed in section 108 and pursuant to Sec.  
1.1502-21T(b)(1). Except to the extent that the member that realizes 
excluded COD income is a member of the separate return limitation year 
subgroup with respect to a tax attribute that arose (or is treated as 
arising) in a separate return limitation year, such attribute is not 
subject to reduction pursuant to this paragraph (a)(4). In addition, 
basis in assets is not subject to reduction pursuant to this paragraph 
(a)(4). Finally, to the extent that the realization of excluded COD 
income by a member pursuant to paragraph (a)(3) does not reduce a tax 
attribute attributable to such lower-tier member, such excess shall not 
be applied to reduce tax attributes attributable to any member pursuant 
to this paragraph (a)(4).
    (b) Special rules--(1) Multiple debtor members--(i) Reduction of 
tax attributes attributable to debtor members prior to reduction of 
consolidated tax attributes. If in a single taxable year multiple 
members realize excluded COD income, paragraphs (a)(2) and (3) of this 
section shall apply with respect to the excluded COD income of each 
such member prior to the application of paragraph (a)(4) of this 
section.
    (ii) Reduction of higher-tier debtor's tax attributes. If in a 
single taxable year multiple members realize excluded COD income and 
one such member is a higher-tier member of another such member, 
paragraphs (a)(2) and (3) of this section shall be applied with respect 
to the excluded COD income of the higher-tier member before such 
paragraphs are applied to the excluded COD income of the other such 
member. A member (the first member) is a higher-tier member of another 
member (the second member) if the first member is the common parent or 
investment adjustments under Sec.  1.1502-32 or Sec.  1.1502-32T with 
respect to the stock of the second member would affect investment 
adjustments with respect to the stock of the first member.
    (iii) Reduction of additional tax attributes. If more than one 
member realizes excluded COD income that has not been applied to reduce 
a tax attribute attributable to such member (the remaining COD amount) 
and the remaining tax attributes available for reduction under 
paragraph (a)(4) of this section are less than the aggregate of the 
remaining COD amounts, after the application of paragraph (a)(2) of 
this

[[Page 52493]]

section, each such member's remaining COD amount shall be applied on a 
pro rata basis (based on the relative remaining COD amounts), pursuant 
to paragraph (a)(4) of this section, to reduce such remaining available 
tax attributes.
    (2) Election under section 108(b)(5). Any member that realizes 
excluded COD income may make the election described in section 
108(b)(5). The election is made separately for each member. Therefore, 
an election may be made for one member that realizes excluded COD 
income (either actually or pursuant to paragraph (a)(3) of this 
section) while another election, or no election, may be made for 
another member that realizes excluded COD income (either actually or 
pursuant to paragraph (a)(3) of this section). See Sec.  1.108-4 for 
rules relating to the procedure for making an election under section 
108(b)(5).
    (3) Limitation of section 1017(b)(2). The limitation of section 
1017(b)(2) on the reduction in basis of property shall be applied by 
reference to the aggregate of the basis of the property held by the 
member that realizes excluded COD income, not the aggregate of the 
basis of the property held by all of the members of the group, and the 
liabilities of such member, not the aggregate liabilities of all of the 
members of the group.
    (c) Examples. The principles of paragraphs (a) and (b) of this 
section are illustrated by the following examples. Unless otherwise 
indicated, no election under section 108(b)(5) has been made. The 
examples are as follows:

    Example 1. (i) Facts. P is the common parent of a consolidated 
group that includes subsidiaries S1 and S2. P owns 80 percent of the 
stock of S1 and 100 percent of the stock of S2. In Year 1, the P 
group sustained a $250 consolidated net operating loss. Under the 
principles of Sec.  1.1502-21T(b)(2)(iv), of that amount, $125 was 
attributable to P and $125 was attributable to S1. On Day 1 of Year 
2, S2 joined the P group. As of the beginning of Year 2, S2 had a 
$50 net operating loss carryover from Year 1, a separate return 
limitation year. In Year 2, the P group sustained a $200 
consolidated net operating loss. Under the principles of Sec.  
1.1502-21T(b)(2)(iv), of that amount, $90 was attributable to P, $70 
was attributable to S1, and $40 was attributable to S2. In Year 3, 
S2 realized $200 of excluded COD income from the discharge of non-
intercompany indebtedness. After the discharge of this indebtedness, 
S2 had no liabilities. In that same year, the P group sustained a 
$50 consolidated net operating loss, of which $40 was attributable 
to S1 and $10 was attributable to S2 under the principles of Sec.  
1.1502-21T(b)(2)(iv). As of the beginning of Year 4, S2 had Asset A 
with a basis of $40 and a fair market value of $10.
    (ii) Analysis--(A) Reduction of tax attributes attributable to 
debtor. Pursuant to paragraph (a)(2) of this section, the tax 
attributes attributable to S2 must first be reduced to take into 
account its excluded COD income in the amount of $200.
    (1) Reduction of net operating losses. Pursuant to section 
108(b)(2)(A), the net operating loss and the net operating loss 
carryovers of S2 are reduced. Pursuant to section 108(b)(4)(B) and 
paragraph (a) of this section, the net operating loss and the net 
operating loss carryovers attributable to S2 under the principles of 
Sec.  1.1502-21T(b)(2)(iv) are reduced first. Accordingly, the 
consolidated net operating loss for Year 3 is reduced by $10, the 
portion of the consolidated net operating loss attributable to S2, 
to $40. Then, again pursuant to section 108(b)(4)(B), S2's net 
operating loss carryover of $50 from its separate return limitation 
year is reduced to $0. Finally, the consolidated net operating loss 
carryover from Year 2 is reduced by $40, the portion of that 
consolidated net operating loss carryover attributable to S2, to 
$160.
    (2) Reduction of basis. Following the reduction of the net 
operating loss and the net operating loss carryovers attributable to 
S2, S2 reduces its basis in its assets pursuant to section 1017 and 
Sec.  1.1017-1. Accordingly, S2 reduces its basis in Asset A by $40, 
from $40 to $0.
    (B) Reduction of remaining consolidated tax attributes. The 
remaining $60 of excluded COD income then reduces consolidated tax 
attributes pursuant to paragraph (a)(4) of this section. In 
particular, the remaining $40 consolidated net operating loss for 
Year 3 is reduced to $0. Then, the consolidated net operating loss 
carryover from Year 1 is reduced by $20 from $250 to $230. Pursuant 
to paragraph (a)(4) of this section, a pro rata amount of the 
consolidated net operating loss carryover from Year 1 that is 
attributable to each of P and S1 is treated as reduced. Therefore, 
$10 of the consolidated net operating loss carryover from Year 1 
that is attributable to each of P and S1 is treated as reduced.
    Example 2. (i) Facts. P is the common parent of a consolidated 
group that includes subsidiaries S1 and S2. P owns 100 percent of 
the stock of S1 and S1 owns 100 percent of the stock of S2. None of 
P, S1, or S2 has a separate return limitation year. In Year 1, the P 
group sustained a $50 consolidated net operating loss. Under the 
principles of Sec.  1.1502-21T(b)(2)(iv), of that amount, $10 was 
attributable to P, $20 was attributable to S1, and $20 was 
attributable to S2. In Year 2, the P group sustained a $70 
consolidated net operating loss. Under the principles of Sec.  
1.1502-21T(b)(2)(iv), of that amount, $30 was attributable to P, $30 
was attributable to S1, and $10 was attributable to S2. In Year 3, 
S1 realized $170 of excluded COD income from the discharge of non-
intercompany indebtedness. After the discharge of this indebtedness, 
S1 and S2 had no liabilities. In that same year, the P group 
sustained a $50 consolidated net operating loss, of which $10 was 
attributable to S1 and $40 was attributable to S2 under the 
principles of Sec.  1.1502-21T(b)(2)(iv). As of the beginning of 
Year 4, S1's sole asset was the stock of S2, and S1 had a $80 basis 
in the S2 stock. In addition, at the beginning of Year 4, S2 had an 
asset with a $0 basis and a $10 value.
    (ii) Analysis--(A) Reduction of tax attributes attributable to 
debtor. Pursuant to paragraph (a)(2) of this section, the tax 
attributes attributable to S1 must first be reduced to take into 
account its excluded COD income in the amount of $170.
    (1) Reduction of net operating losses. Pursuant to section 
108(b)(2)(A), the net operating loss and the net operating loss 
carryovers of S1 are reduced. Pursuant to section 108(b)(4)(B) and 
paragraph (a) of this section, the net operating loss and the net 
operating loss carryovers attributable to S1 under the principles of 
Sec.  1.1502-21T(b)(2)(iv) are reduced first. Accordingly, the 
consolidated net operating loss for Year 3 is reduced by $10, the 
portion of the consolidated net operating loss for Year 3 
attributable to S1, to $40. Then, the consolidated net operating 
loss carryover from Year 1 is reduced by $20, the portion of that 
consolidated net operating loss carryover attributable to S1, to 
$30, and the consolidated net operating loss carryover from Year 2 
is reduced by $30, the portion of that consolidated net operating 
loss carryover attributable to S1, to $40.
    (2) Reduction of basis. Following the reduction of the net 
operating loss and the net operating loss carryovers attributable to 
S1, S1 reduces its basis in its assets pursuant to section 1017 and 
Sec.  1.1017-1. Accordingly, S1 reduces its basis in the stock of S2 
by $80, from $80 to $0.
    (3) Tiering down of stock basis reduction. Pursuant to paragraph 
(a)(3) of this section, for purposes of sections 108 and 1017 and 
this section, S2 is treated as realizing $80 of excluded COD income. 
Accordingly, the consolidated net operating loss for Year 3 is 
reduced by an additional $40, the portion of the consolidated net 
operating loss for Year 3 attributable to S2, to $0. Then, the 
consolidated net operating loss carryover from Year 1 is reduced by 
$20, the portion of that consolidated net operating loss carryover 
attributable to S2, to $10. Then, the consolidated net operating 
loss carryover from Year 2 is reduced by $10, the portion of that 
consolidated net operating loss carryover attributable to S2, to 
$30. S2's remaining $10 of excluded COD income does not reduce 
consolidated tax attributes attributable to P or S1 under paragraph 
(a)(4) of this section.
    (B) Reduction of remaining consolidated tax attributes. Finally, 
pursuant to paragraph (a)(4) of this section, S1's remaining $30 of 
excluded COD income reduces the remaining consolidated tax 
attributes. In particular, the remaining $10 consolidated net 
operating loss carryover from Year 1 is reduced by $10 to $0, and 
the remaining $30 consolidated net operating loss carryover from 
Year 2 is reduced by $20 to $10.
    Example 3. (i) Facts. P is the common parent of a consolidated 
group that includes subsidiaries S1, S2, and S3. P owns 100 percent 
of the stock of S1, S1 owns 100 percent of the stock of S2, and S2 
owns 100 percent of the stock of S3. In Year 1, the P group 
sustained a $150 consolidated net operating loss. Under the 
principles of Sec.  1.1502-21T(b)(2)(iv), of that amount, $50 was 
attributable to S2, and $100 was attributable to S3. In Year 2, the 
P group

[[Page 52494]]

sustained a $50 consolidated net operating loss. Under the 
principles of Sec.  1.1502-21T(b)(2)(iv), of that amount, $40 was 
attributable to S1 and $10 was attributable to S2. In Year 3, S1 
realized $170 of excluded COD income from the discharge of non-
intercompany indebtedness. After the discharge of this indebtedness, 
S1, S2, and S3 had no liabilities. In that same year, the P group 
sustained a $50 consolidated net operating loss, of which $10 was 
attributable to S1, $20 was attributable to S2, and $20 was 
attributable to S3 under the principles of Sec.  1.1502-
21T(b)(2)(iv). At the beginning of Year 4, S1's only asset was the 
stock of S2, with a basis of $120, and S2's only asset was the stock 
of S3 with a basis of $180 and a value of $10. None of P, S1, or S2 
had a separate return limitation year.
    (ii) Analysis--Reduction of tax attributes attributable to 
debtor. Pursuant to paragraph (a)(2) of this section, the tax 
attributes attributable to S1 must first be reduced to take into 
account its excluded COD income in the amount of $170.
    (A) Reduction of net operating losses. Pursuant to section 
108(b)(2)(A), the net operating loss and the net operating loss 
carryovers of S1 are reduced. Pursuant to section 108(b)(4)(B) and 
paragraph (a) of this section, the net operating loss and the net 
operating loss carryovers attributable to S1 under the principles of 
Sec.  1.1502-21T(b)(2)(iv) are reduced first. Pursuant to section 
108(b)(4)(B), S1's net operating loss for the taxable year of the 
discharge is reduced first. Accordingly, the consolidated net 
operating loss for Year 3 is reduced by $10, the portion of the 
consolidated net operating loss attributable to S1, to $40. Then, 
again pursuant to section 108(b)(4)(B), the consolidated net 
operating loss carryover from Year 2 is reduced by $40, the portion 
of that consolidated net operating loss carryover attributable to 
S1, to $10.
    (B) Reduction of basis. Following the reduction of the net 
operating loss and the net operating loss carryovers attributable to 
S1, S1 reduces its basis in its assets pursuant to section 1017 and 
Sec.  1.1017-1. Accordingly, S1 reduces its basis in the stock of S2 
by $120, from $120 to $0.
    (C) Tiering down of stock basis reduction to S2. Pursuant to 
paragraph (a)(3) of this section, for purposes of sections 108 and 
1017 and this section, S2 is treated as realizing $120 of excluded 
COD income. Pursuant to section 108(b)(2)(A), therefore, the net 
operating loss and net operating loss carryovers of S2 are reduced. 
Pursuant to section 108(b)(4)(B) and paragraph (a) of this section, 
the net operating loss and the net operating loss carryovers 
attributable to S2 under the principles of Sec.  1.1502-
21T(b)(2)(iv) are reduced. Pursuant to section 108(b)(4)(B), S2's 
net operating loss for the taxable year of the discharge is reduced. 
Accordingly, the consolidated net operating loss for Year 3 is 
further reduced by $20, the portion of the consolidated net 
operating loss attributable to S2, to $20. Then, again pursuant to 
section 108(b)(4)(B), the consolidated net operating loss carryover 
from Year 1 is reduced by $50, the portion of that consolidated net 
operating loss carryover attributable to S2, to $100. Then, again 
pursuant to section 108(b)(4)(B), the consolidated net operating 
loss carryover from Year 2 is further reduced by $10, the portion of 
that consolidated net operating loss carryover attributable to S2, 
to $0. Following the reduction of the net operating loss and the net 
operating loss carryovers attributable to S2, S2 reduces its basis 
in its assets pursuant to section 1017 and Sec.  1.1017-1. 
Accordingly, S2 reduces its basis in its S3 stock by $40 to $140.
    (D) Tiering down of stock basis reduction to S3. Pursuant to 
paragraph (a)(3) of this section, for purposes of sections 108 and 
1017 and this section, S3 is treated as realizing $40 of excluded 
COD income. Pursuant to section 108(b)(2)(A), therefore, the net 
operating loss and the net operating loss carryovers of S3 are 
reduced. Pursuant to section 108(b)(4)(B) and paragraph (a) of this 
section, the net operating loss and the net operating loss 
carryovers attributable to S3 under the principles of Sec.  1.1502-
21T(b)(2)(iv) are reduced. Pursuant to section 108(b)(4)(B), S3's 
net operating loss for the taxable year of the discharge is reduced. 
Accordingly, the consolidated net operating loss for Year 3 is 
further reduced by $20, the portion of the consolidated net 
operating loss attributable to S3, to $0. Then, again pursuant to 
section 108(b)(4)(B), the consolidated net operating loss carryover 
from Year 1 is reduced by $20, the lesser of the portion of that 
consolidated net operating loss carryover attributable to S3 and the 
remaining excluded COD income, to $80.
    Example 4. (i) Facts. P is the common parent of a consolidated 
group that includes subsidiaries S1, S2, and S3. P owns 100 percent 
of the stock of each of S1 and S2. Each of S1 and S2 owns stock of 
S3 that represents 50 percent of the value of the stock of S3. In 
Year 1, the P group sustained a $160 consolidated net operating 
loss. Under the principles of Sec.  1.1502-21T(b)(2)(iv), of that 
amount, $10 was attributable to P, $50 was attributable to S2, and 
$100 was attributable to S3. In Year 2, the P group sustained a $110 
consolidated net operating loss. Under the principles of Sec.  
1.1502-21T(b)(2)(iv), of that amount, $40 was attributable to S1 and 
$70 was attributable to S2. In Year 3, S1 realized $200 of excluded 
COD income from the discharge of non-intercompany indebtedness, and 
S2 realized $270 of excluded COD income from the discharge of non-
intercompany indebtedness. After the discharge of this indebtedness, 
S1, S2, and S3 had no liabilities. In that same year, the P group 
sustained a $50 consolidated net operating loss, of which $10 was 
attributable to S1, $20 was attributable to S2, and $20 was 
attributable to S3 under the principles of Sec.  1.1502-
21T(b)(2)(iv). At the beginning of Year 4, S1's basis in its S3 
stock was $60, S2's basis in its S3 stock was $120, and S3 had one 
asset with a basis of $200 and a value of $10. None of P, S1, S2, or 
S3 had a separate return limitation year.
    (ii) Analysis--Reduction of tax attributes attributable to 
debtors. Pursuant to paragraph (b)(1)(i) of this section, the tax 
attributes attributable to each of S1 and S2 are reduced pursuant to 
paragraph (a)(2) of this section, and the tax attributes 
attributable to S3 are reduced pursuant to paragraph (a)(3) of this 
section so as to reflect a reduction of S1's and S2's basis in the 
stock of S3 prior to the application of paragraph (a)(4) to reduce 
additional tax attributes. Pursuant to paragraph (a)(2) of this 
section, the tax attributes attributable to S1 and S2 must be 
reduced to take into account their excluded COD income.
    (A) Reduction of net operating losses generally. Pursuant to 
section 108(b)(2)(A), the net operating losses and the net operating 
loss carryovers of S1 and S2 are reduced. Pursuant to section 
108(b)(4)(B) and paragraph (a) of this section, the net operating 
losses and the net operating loss carryovers attributable to S1 and 
S2 under the principles of Sec.  1.1502-21T(b)(2)(iv) are reduced 
first.
    (B) Reduction of net operating losses attributable to S1. 
Pursuant to section 108(b)(4)(B), S1's net operating loss for the 
taxable year of the discharge is reduced. Accordingly, the 
consolidated net operating loss for Year 3 is reduced by $10, the 
portion of the consolidated net operating loss attributable to S1, 
to $40. Then, again pursuant to section 108(b)(4)(B), the 
consolidated net operating loss carryover from Year 2 is reduced by 
$40, the portion of that consolidated net operating loss carryover 
attributable to S1, to $70.
    (C) Reduction of net operating losses attributable to S2. 
Pursuant to section 108(b)(4)(B), S2's net operating loss for the 
taxable year of the discharge is reduced. Accordingly, the 
consolidated net operating loss for Year 3 is further reduced by 
$20, the portion of the consolidated net operating loss attributable 
to S2, to $20. Then, pursuant to section 108(b)(4)(B), the 
consolidated net operating loss carryover from Year 1 is reduced by 
$50, the portion of that consolidated net operating loss carryover 
attributable to S2, to $110. Then, again pursuant to section 
108(b)(4)(B), the consolidated net operating loss carryover from 
Year 2 is further reduced by $70, the portion of that consolidated 
net operating loss carryover attributable to S2, to $0.
    (D) Reduction of basis. Following the reduction of the net 
operating losses and the net operating loss carryovers attributable 
to S1 and S2, S1 and S2 must reduce their basis in their assets 
pursuant to section 1017 and Sec.  1.1017-1. Accordingly, S1 reduces 
its basis in the stock of S3 by $60, from $60 to $0, and S2 reduces 
its basis in the stock of S3 by $120, from $120 to $0.
    (E) Tiering down of basis reduction. Pursuant to paragraph 
(a)(3) of this section, for purposes of sections 108 and 1017 and 
this section, S3 is treated as realizing $180 of excluded COD 
income. Pursuant to section 108(b)(2)(A), therefore, the net 
operating loss and the net operating loss carryovers of S3 are 
reduced, in the order indicated by section 108(b)(4)(B). Pursuant to 
paragraph (a)(2) of this section the consolidated net operating loss 
and any consolidated net operating loss carryovers that are 
attributable to S3 under the principles of Sec.  1.1502-
21T(b)(2)(iv) are reduced. Accordingly, the consolidated net 
operating loss for Year 3 is further reduced by $20, the portion of 
the consolidated net operating loss attributable to S3, to $0. Then, 
the consolidated net operating loss carryover from Year 1 is reduced 
by $100, the portion

[[Page 52495]]

of that consolidated net operating loss carryover attributable to 
S3, to $10. Following the reduction of the net operating loss and 
the net operating loss carryover attributable to S3, S3 reduces its 
basis in its asset pursuant to section 1017 and Sec.  1.1017-1. 
Accordingly, S3 reduces its basis in its asset by $60, from $200 to 
$140.
    (F) Reduction of remaining consolidated tax attributes. Finally, 
pursuant to paragraph (a)(4) of this section, the remaining $90 of 
S1's excluded COD income and the remaining $10 of S2's excluded COD 
income reduce the remaining consolidated tax attributes. In 
particular, the remaining $10 consolidated net operating loss 
carryover from Year 1 is reduced by $10 to $0. Because that amount 
is less than the aggregate amount of remaining excluded COD income, 
such income is applied on a pro rata basis to reduce the remaining 
consolidated tax attributes. Accordingly, $9 of S1's remaining 
excluded COD income and $1 of S2's remaining excluded COD income is 
applied to reduce the remaining consolidated net operating loss 
carryover from Year 1. Consequently, of S1's excluded COD income of 
$200, only $119 is applied to reduce tax attributes, and, of S2's 
excluded COD income of $270, only $261 is applied to reduce tax 
attributes.

    (d) Effective date. This section applies to discharges of 
indebtedness that occur after August 29, 2003.

0
Par. 7. Section 1.1502-32 is amended as follows:
0
1. Paragraphs (b)(3)(ii)(C)(1) and (b)(3)(iii)(A) are revised.
0
2. Paragraph (b)(4)(vii) is added.
0
3. Paragraph (b)(5)(ii), Example 4, paragraphs (a), (b), and (c), are 
revised.
0
4. Paragraph (h)(7) is added.
    The revisions and additions read as follows:


Sec.  1.1502-32  Investment adjustments.

* * * * *
    (b) * * *
    (3) * * *
    (ii) * * *
    (C) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.1502-
32T(b)(3)(ii)(C)(1).
* * * * *
    (iii) * * *
    (A) [Reserved]. For further guidance, see Sec.  1.1502-
32T(b)(3)(iii)(A).
* * * * *
    (4) * * *
    (vii) [Reserved]. For further guidance, see Sec.  1.1502-
32T(b)(4)(vii).
    (5) * * *
    (ii) * * *
    Example 4(a), (b), and (c) [Reserved]. For further guidance, see 
Sec.  1.1502-32T(b)(5)(ii), Example 4(a), (b), and (c).
* * * * *
    (h) * * *
    (7) [Reserved]. For further guidance, see Sec.  1.1502-32T(h)(7).

0
Par. 8. Section 1.1502-32T is amended as follows:
0
1. Paragraphs (b) through (b)(3)(iii)(B) are revised.
0
2. Add and reserve paragraph (b)(3)(iv), and revise paragraphs (b)(4) 
through (b)(4)(iv).
0
3. Add paragraph (b)(5) and revise paragraphs (c) through (h)(5)(ii).
0
4. Paragraph (h)(7) is added.
    The revisions and addition read as follows:


Sec.  1.1502-32T  Investment adjustments (temporary).

* * * * *
    (b) through (b)(3)(ii)(B) [Reserved]. For further guidance, see 
Sec.  1.1502-32(b) through (b)(3)(ii)(B).
    (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 attributable to any 
member of the group under section 108, section 1017, or Sec.  1.1502-
28T. If S is treated as realizing discharge of indebtedness income that 
is excluded from gross income pursuant to Sec.  1.1502-28T(a)(3), S 
shall not be treated as realizing excluded COD income for purposes of 
the preceding sentence.
    (b)(3)(ii)(C)(2) through (b)(3)(ii)(D) [Reserved]. For further 
guidance, see Sec.  1.1502-32(b)(3)(ii)(C)(2) through (b)(3)(ii)(D).
    (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 Federal taxes described in section 
275 and loss not recognized under section 311(a) are noncapital, 
nondeductible expenses. Similarly, if a loss carryover (e.g., under 
section 172 or 1212) attributable to S expires or is reduced under 
section 108(b) and Sec.  1.1502-28T, it becomes a noncapital, 
nondeductible expense at the close of the last tax year to which it may 
be carried. However, when a tax attribute attributable to S is reduced 
as required pursuant to Sec.  1.1502-28T(a)(3), the reduction of the 
tax attribute is not treated as a noncapital, nondeductible expense of 
S. Finally, if S sells and repurchases a security subject to section 
1091, the disallowed loss is not a noncapital, nondeductible expense 
because the corresponding basis adjustments under section 1091(d) 
prevent the disallowance from being permanent.
    (b)(3)(iii)(B) [Reserved]. For further guidance, see Sec.  1.1502-
32(b)(3)(iii)(B).
* * * * *
    (b)(3)(iv) through (b)(4)(iv) [Reserved]. For further guidance, see 
Sec.  1.1502-32(b)(3)(iv) through (b)(4)(iv).
* * * * *
    (b)(5)(i) through (b)(5)(ii), Example 3 [Reserved]. For further 
guidance, see Sec.  1.1502-32(b)(5)(i) through (b)(5)(ii), Example 3.

    Example 4. Discharge of indebtedness. (a) Facts. P forms S on 
January 1 of Year 1 and S borrows $200. During Year 1, S's assets 
decline in value and the P group has a $100 consolidated net 
operating loss. Of that amount, $10 is attributable to P and $90 is 
attributable to S under the principles of Sec.  1.1502-
21T(b)(2)(iv). None of the loss is absorbed by the group in Year 1, 
and S is discharged from $100 of indebtedness at the close of Year 
1. P has a $0 basis in the S stock. P and S have no attributes other 
than the consolidated net operating loss. Under section 108(a), S's 
$100 of discharge of indebtedness income is excluded from gross 
income because of insolvency. Under section 108(b) and Sec.  1.1502-
28T, the consolidated net operating loss is reduced to $0.
    (b) Analysis. Under Sec.  1.1502-32(b)(3)(iii)(B), the reduction 
of $90 of the consolidated net operating loss attributable to S is 
treated as a noncapital, nondeductible expense in Year 1 because 
that loss is permanently disallowed by section 108(b) and Sec.  
1.1502-28T. Under paragraph (b)(3)(ii)(C)(1) of this section, all 
$100 of S's discharge of indebtedness income is treated as tax-
exempt income in Year 1 because the discharge results in a $100 
reduction to the consolidated net operating loss. Consequently, the 
loss and the cancellation of the indebtedness result in a net 
positive $10 adjustment to P's basis in its S stock.
    (c) Insufficient attributes. The facts are the same as in 
paragraph (a) of this Example 4, except that S is discharged from 
$120 of indebtedness at the close of Year 1. Under section 108(a), 
S's $120 of discharge of indebtedness income is excluded from gross 
income because of insolvency. Under section 108(b) and Sec.  1.1502-
28T, the consolidated net operating loss is reduced to $0 at the 
close of Year 1. Under Sec.  1.1502-32(b)(3)(iii)(B), the reduction 
of $90 of the consolidated net operating loss attributable to S is 
treated as a noncapital, nondeductible expense. Under paragraph 
(b)(3)(ii)(C)(1) of this section, only $100 of the discharge is 
treated as tax-exempt income because only that amount is applied to 
reduce tax attributes. The remaining $20 of discharge income 
excluded under section 108(a) has no effect on P's basis in S's 
stock.
    (b)(5)(ii), Example 4(d) through (h)(5)(ii) [Reserved]. For 
further guidance, see Sec.  1.1502-32(b)(5)(ii), Example 4(d) 
through (h)(5)(ii).
* * * * *
    (h)(7) Rules related to discharges of indebtedness excluded from 
gross income. Paragraphs (b)(3)(ii)(C)(1), (b)(3)(iii)(A), and

[[Page 52496]]

(b)(5)(ii), Example 4, paragraphs (a), (b), and (c), of this section 
apply with respect to determinations of the basis of the stock of a 
subsidiary in consolidated return years the original return for 
which is due (without extensions) after August 29, 2003. For 
determinations in consolidated return years the original return for 
which is due (without extensions) on or before August 29, 2003, 
groups may apply paragraphs (b)(3)(ii)(C)(1), (b)(3)(iii)(A), and 
(b)(5)(ii), Example 4, paragraphs (a), (b), and (c), of this section 
without regard to the references to Sec.  1.1502-28T or, 
alternatively, apply paragraphs (b)(3)(ii)(C)(1), (b)(3)(iii)(A), 
and (b)(5)(ii), Example 4, paragraphs (a), (b), and (c), of Sec.  
1.1502-32 as contained in 26 CFR part 1 edition revised as of April 
1, 2003.

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: August 28, 2003.
Gregory F. Jenner,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 03-22453 Filed 8-29-03; 3:14 pm]
BILLING CODE 4830-01-P