[Federal Register Volume 69, Number 50 (Monday, March 15, 2004)]
[Proposed Rules]
[Pages 12091-12098]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5667]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-167265-03]
RIN 1545-BC95


Guidance Under Section 1502; Application of Section 108 to 
Members of a Consolidated Group; Computation of Taxable Income When 
Section 108 Applies to a Member of a Consolidated Group

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking; notice of proposed rulemaking by 
cross reference to temporary regulations.

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SUMMARY: This document contains proposed regulations under section 1502 
that govern the timing of certain basis adjustments in respect of the 
realization of discharge of indebtedness income that is excluded from 
gross income and the reduction of attributes in respect of that 
excluded income. In addition, the text of the temporary regulations 
published elsewhere in the Rules and Regulations section of this issue 
of the Federal Register serves as the text of these proposed 
regulations with respect to the application of section 108 when a 
member of a consolidated group realizes discharge of indebtedness 
income. The proposed regulations affect corporations filing 
consolidated returns.

DATES: Written or electronic comments must be received by June 14, 
2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-167265-03), room 
5203, 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 4 p.m. to: CC:PA:LPD:PR (REG-
167265-03), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
comments electronically directly to the IRS Internet site at http://www.irs.gov/regs.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Candace B. Ewell or Marie C. Milnes-Vasquez at (202) 622-7530; 
concerning submission of comments, Treena Garrett at (202) 622-3401 
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    On September 4, 2003, the IRS and Treasury Department published in 
the Federal Register a notice of proposed rulemaking (REG-132760-03, 68 
FR 52542) and temporary regulations (TD 9089, 68 FR 52487) under 
section 1502 of the Internal Revenue Code. The temporary regulations 
added Sec.  1.1502-28T, which provides guidance regarding the 
determination of the attributes that are available for reduction when a 
member of a consolidated group realizes discharge of indebtedness 
income that is excluded from gross income (excluded COD income) and the 
method for reducing those attributes.
    The text of the temporary regulations published in the Rules and 
Regulations section of this issue of the Federal Register amend the 
Income Tax Regulations (26 CFR part 1) relating to section 1502. The 
temporary regulations address certain issues related to the application 
of section 1245 and the matching rule of Sec.  1.1502-13, and the 
inclusion of excess loss accounts in cases in which excluded COD is not 
fully applied to reduce attributes. The text of those regulations also 
serves as the text of these proposed regulations with respect to those 
issues. The preamble to the temporary regulations explains those 
amendments.
    These regulations also propose amendments to Sec. Sec.  1.1502-28T 
and 1.1502-11 to address certain issues that have been raised regarding 
the computation of gain or loss on the disposition of member stock and 
regarding the computation of the portion of an excess loss account that 
must be taken into account when excluded COD income is not fully 
applied to reduce attributes. In particular, if the stock of the 
subsidiary that realizes excluded COD income is sold, the reduction of 
other members' attributes will cause an increase in the basis of the 
stock of the subsidiary, thus reducing the gain (or increasing the 
loss) on the stock sale that might otherwise have been offset by 
attributes and possibly making more attributes available for reduction. 
If the stock of a subsidiary other than one that realizes excluded COD 
income is sold, the reduction of such subsidiary's attributes in 
respect of the excluded COD income will cause a decrease in the basis 
of the sold subsidiary stock, thus increasing the gain (or reducing the 
loss) on the stock sale, possibly resulting in the absorption of more 
attributes and making fewer attributes available for reduction.
    In addition, the amount of the excess loss account in the stock of 
a subsidiary that is required to be taken into account can only be 
determined after the computation of tax for the year of the discharge 
and the reduction of attributes. Pursuant to Sec.  1.1502-
28T(b)(6)(ii), however, that excess loss account must be included on 
the group's tax return for the taxable year that includes the date on 
which the subsidiary realizes the excluded COD income. If that excess 
loss account were offset by losses that could be reduced in respect of 
the excluded COD income, the inclusion of that amount could result in 
fewer attributes available for reduction. The availability of fewer 
attributes for reduction might increase the excluded COD income that 
was not applied to reduce attributes and, therefore, the amount of the 
excess loss account in the subsidiary's stock required to be taken into 
account.
    These regulations provide guidance regarding the timing of stock 
basis adjustments, the calculation of stock gain or loss (including the 
amount of an excess loss account required to be taken into account), 
and the reduction of attributes when a member (P) disposes of stock of 
a subsidiary (S) during a year in which a member realizes excluded COD 
income. In particular, these regulations propose the steps used to 
compute the group's consolidated taxable income and to effect the 
reduction of attributes. In order to avoid circular calculations, these 
proposed regulations adopt an approach that limits the reduction of 
attributes in certain cases in which a disposition of subsidiary stock 
occurs during a year in which one or more members realize excluded COD 
income.
    This methodology applies not only when there is an actual 
disposition of subsidiary stock, but also when there is a deemed 
disposition, including a disposition that results by reason of the 
application of Sec.  1.1502-19(c)(1)(iii)(B) when excluded COD income 
is not fully applied to reduce attributes. However, in order to know 
whether there has been a disposition of stock by reason of the 
application of Sec.  1.1502-19(c)(1)(iii)(B), the group must have 
computed its consolidated taxable income (or loss) and applied the 
rules of sections 108 and 1017 and Sec.  1.1502-28T. Therefore, as 
discussed below, a number of the steps proposed will have a slightly 
different application when there is such

[[Page 12092]]

a deemed disposition of subsidiary stock rather than an actual 
disposition of subsidiary stock. The following paragraphs outline the 
proposed steps.
    First, the extent to which S's deductions and losses for the tax 
year of the disposition (and its deductions and losses carried over 
from prior years) may offset income and gain is computed pursuant to 
the current rules of Sec.  1.1502-11(b)(2) and (3). Those rules require 
a tentative computation of the group's taxable income, without regard 
to the stock gain or loss. In the case of a disposition of subsidiary 
stock that results from the application of Sec.  1.1502-
19(c)(1)(iii)(B) (which will only be apparent after the application of 
the sixth step described below), the application of Sec.  1.1502-
11(b)(2) and (3) will not result in the imposition of a limitation on 
the use of S's deductions and losses.
    Second, Sec. Sec.  1.1502-32 and 1.1502-32T are tentatively applied 
to adjust the basis of the S stock to reflect the amount of S's 
unlimited deductions and losses that are absorbed in the tentative 
computation of taxable income (or loss) for the year of the disposition 
(and any prior years to which the deductions or losses may be carried) 
that is made pursuant to Sec.  1.1502-11(b)(2). The basis of the S 
stock is not adjusted to reflect the realization of excluded COD income 
and the reduction of attributes in respect thereof.
    Third, in the case of a disposition of S stock that does not result 
from excluded COD income not being fully applied to reduce attributes, 
P's income, gain, or loss from the disposition of S stock is computed 
using the basis of such stock computed in the preceding step.
    Fourth, taxable income (or loss) for the year of disposition (and 
any prior years to which the deductions or losses may be carried) is 
tentatively computed. For this purpose, in the case of a disposition of 
S stock that does not result from excluded COD income not being fully 
applied to reduce attributes, the tentative computations of taxable 
income (or loss) take into account P's income, gain, or loss from the 
disposition of S stock computed in the preceding step. Any excess loss 
account that is taken into account as a result of excluded COD income 
not being fully applied to reduce attributes is not included in this 
tentative computation of taxable income (or loss).
    Fifth, the excluded COD income is tentatively applied to reduce 
attributes pursuant to the rules of sections 108 and 1017 and Sec.  
1.1502-28T. Only those attributes that remain after the tentative 
computations of taxable income (or loss) in the fourth step are subject 
to reduction.
    Sixth, Sec. Sec.  1.1502-32 and 1.1502-32T are applied to adjust 
the basis of the S stock to reflect the amount of S's unlimited 
deductions and losses that are absorbed in the tentative computation of 
taxable income (or loss) for the year of the disposition (and any prior 
years to which the deductions or losses may be carried) made pursuant 
to the fourth step, and the excluded COD income that is applied to 
reduce attributes and the attributes reduced in respect of the excluded 
COD income pursuant to the fifth step.
    Seventh, the group's actual gain or loss on the disposition of S 
stock is computed using the basis of such stock computed in the 
preceding step. At this point, whether and to what extent an excess 
loss account in the stock of a subsidiary that realizes excluded COD 
income must be taken into account is computed. In many cases, taking 
into account the basis consequences of the excluded COD income prior to 
computing the amount of an excess loss account required to be taken 
into account may be favorable to taxpayers because those consequences 
might decrease or even eliminate an excess loss account and, therefore, 
reduce the amount of excess loss account required to be taken into 
account. The IRS and Treasury Department are aware that taking into 
account the basis effects of the excluded COD income of all members of 
the group may increase the excess loss account in the subsidiary stock. 
This result may occur in a case in which the excluded COD income of one 
subsidiary (the first subsidiary) is not fully applied to reduce 
attributes and the excluded COD income of another subsidiary (the 
second subsidiary) is applied to reduce attributes in the first 
subsidiary's chain. The IRS and Treasury Department nevertheless 
believe that this result is not inappropriate as the reduction of an 
attribute in the first subsidiary's chain in respect of excluded COD 
income of the second subsidiary may avoid taking into account an excess 
loss account in the second subsidiary's stock.
    Eighth, the taxable income (or loss) for the year of the 
disposition (and any prior years to which the deductions or losses may 
be carried) is computed. These amounts are calculated by applying the 
limitation on the use of S's deductions and losses to offset income 
computed pursuant to the first step, and by including the gain or loss 
recognized on the disposition of S stock computed pursuant to the 
preceding step. However, attributes that were tentatively used to 
offset income in the tentative computation of taxable income (or loss) 
in the fourth step and attributes that were tentatively reduced in the 
fifth step cannot offset any excess loss account taken into account as 
a result of excluded COD income not being fully applied to reduce 
attributes. This limitation gives effect to the requirement that the 
excess loss account be taken into account and avoids circular 
calculations. If an excess loss account that is taken into account as a 
result of excluded income could be offset by attributes that could be 
reduced in respect of the excluded COD income, the use of attributes to 
offset the excess loss account could result in fewer attributes 
available for reduction and a greater amount of excluded COD income 
that was not applied to reduce attributes, which, in turn, would 
increase the amount of the excess loss account required to be taken 
into account. Ultimately, the inclusion of the excess loss account and 
the realization of excluded COD income could have no effect on the 
overall tax liability of the group, thereby rendering meaningless the 
requirement to take into account the excess loss account.
    Ninth, the excluded COD income is actually applied to reduce 
attributes pursuant to the rules of sections 108 and 1017 and Sec.  
1.1502-28T. Only those attributes remaining after the actual 
computations of taxable income (or loss) pursuant to the eighth step 
are subject to reduction in the ninth step. In certain cases, however, 
the reduction of attributes will be limited to prevent circular 
calculations. The proposed regulations include two rules in this 
regard.
    The first rule provides that when S or a subsidiary of S realizes 
excluded COD income, the aggregate amount of excluded COD income that 
is applied to reduce attributes attributable to members other than S 
and any lower-tier corporation of S cannot exceed the aggregate amount 
of excluded COD income that is applied to reduce attributes 
attributable to members other than S and any lower-tier corporation of 
S pursuant to the fifth step (tentative reduction of attributes). 
Without this limitation, the amount of excluded COD income applied to 
reduce attributes could exceed the amount of excluded COD income 
applied to reduce attributes in the fifth step, which would result in a 
greater positive adjustment (or a lesser negative adjustment) to the 
basis of the S stock compared to that made in the sixth step, and 
reduce the gain (or increase the loss) recognized on the disposition of 
the S stock, which might increase the attributes available for 
reduction and the amount of

[[Page 12093]]

excluded COD income applied to reduce attributes.
    The second rule provides that when a member other than S or a 
subsidiary of S realizes excluded COD income, the aggregate amount of 
excluded COD income that is applied to reduce attributes (other than 
credits) attributable to S and any lower-tier corporation of S cannot 
exceed the aggregate amount of excluded COD income that is applied to 
reduce attributes (other than credits) attributable to S and any lower-
tier corporation of S in the fifth step. Without this limitation, the 
amount of excluded COD income applied to reduce the attributes (other 
than credits) attributable to S or a subsidiary of S could exceed the 
amount of excluded COD income applied to reduce the attributes (other 
than credits) attributable to S or a subsidiary of S in the fifth step, 
which would result in a lesser positive adjustment (or a greater 
negative adjustment) to the basis of the S stock compared to that made 
in the sixth step, and increase the gain (or decrease the loss) 
recognized on the disposition of the S stock, which might decrease the 
attributes of S's shareholder available for reduction, increase the 
reduction of S's attributes, and result in a lesser positive adjustment 
(or a greater negative adjustment) to the basis of the S stock.
    The IRS and Treasury Department are aware that the foregoing 
methodology does not prevent circular calculations in all cases, 
specifically certain cases in which there is a disposition of the stock 
of more than one subsidiary. The IRS and Treasury Department request 
comments regarding whether rules preventing circular calculations in 
these other cases are necessary. If such rules are necessary, the IRS 
and Treasury Department request comments regarding the approach that 
those rules should adopt.
    Given the difficulty of the problem addressed by these regulations, 
the IRS and Treasury Department request comments regarding these rules 
prior to making them effective. Therefore, the rules described above 
are proposed. Before these rules are adopted as temporary or final 
regulations, taxpayers may rely on the rules proposed in these 
regulations.

Special Analysis

    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. Further, it 
is hereby certified that these regulations will not have a significant 
economic impact on a substantial number of small entities. This 
certification is based on the fact that these regulations will 
primarily affect affiliated groups of corporations that have elected to 
file consolidated returns, which tend to be larger businesses. 
Accordingly, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to 
section 7805(f) of the Internal Revenue Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and Treasury Department request comments on the clarity of 
the proposed rules and how they can be made easier to understand. All 
comments will be available for public inspection and copying. A public 
hearing will be scheduled if requested in writing by any person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the hearing will be published 
in the Federal Register.

Drafting Information

    The principal author of these regulations is Marie C. Milnes-
Vasquez of the Office of Associate Chief Counsel (Corporate). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

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

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read, in part as follows:

    Authority: 26 U.S.C. 7805. * * *
    Section 1.1502-28 also issued under 26 U.S.C. 1502. * * *

    Par. 2. Section 1.1502-11 is amended by:
    1. Revising paragraph (b)(1).
    2. Redesignating paragraph (c) as paragraph (d).
    3. Adding new paragraph (c).
    The revision and addition read as follows:


Sec.  1.1502-11  Consolidated taxable income.

* * * * *
    (b) Elimination of circular stock basis adjustments when there is 
no excluded COD income--(1) In general. If one member (P) disposes of 
the stock of another member (S), this paragraph (b) limits the use of 
S's deductions and losses in the year of disposition and the carryback 
of items to prior years. The purpose of the limitation is to prevent 
P's income or gain from the disposition of S's stock from increasing 
the absorption of S's deductions and losses, because the increased 
absorption would reduce P's basis (or increase its excess loss account) 
in S's stock under Sec.  1.1502-32 and, in turn, increase P's income or 
gain. See paragraph (b)(3) of this section for the application of these 
principles to P's deduction or loss from the disposition of S's stock, 
and paragraph (b)(4) of this section for the application of these 
principles to multiple stock dispositions. This paragraph (b) applies 
only when no member realizes discharge of indebtedness income that is 
excluded from gross income under section 108(a) (excluded COD income) 
during the taxable year of the disposition. See paragraph (c) of this 
section for rules that apply when a member realizes excluded COD income 
during the taxable year of the disposition. See Sec.  1.1502-19(c) for 
the definition of disposition.
* * * * *
    (c) Elimination of circular stock basis adjustments when there is 
excluded COD income--(1) In general. If one member (P) disposes of the 
stock of another member (S) in a year during which any member realizes 
excluded COD income, this paragraph (c) limits the use of S's 
deductions and losses in the year of disposition and the carryback of 
items to prior years, the amount of the attributes of certain members 
that can be reduced in respect of excluded COD income of certain other 
members, and the attributes that can be used to offset an excess loss 
account taken into account by reason of the application of Sec.  
1.1502-19(c)(1)(iii)(B). In addition to the purpose set forth in 
paragraph (b)(1) of this section, the purpose of these limitations is 
to prevent the reduction of tax attributes in respect of excluded COD 
income from affecting P's income, gain, or loss on the disposition of S 
stock (including a disposition of S stock that results from the 
application of Sec.  1.1502-19(c)(1)(iii)(B)) and, in turn,

[[Page 12094]]

affecting the attributes available for reduction pursuant to sections 
108 and 1017 and Sec.  1.1502-28T.
    (2) Computation of taxable income, reduction of attributes, and 
computation of limits on absorption and reduction of attributes. If a 
member realizes excluded COD income in the taxable year during which P 
disposes of S stock, the steps used to compute taxable income (or 
loss), to effect the reduction of attributes, and to compute the 
limitations on the absorption and reduction of attributes are as 
follows. These steps also apply to determine whether and to what extent 
an excess loss account must be taken into account as a result of the 
application of Sec. Sec.  1.1502-19(c)(1)(iii)(B) and 1.1502-19T(b)(1).
    (i) Limitation on deductions and losses to offset income or gain. 
First, the determination of the extent to which S's deductions and 
losses for the tax year of the disposition (and its deductions and 
losses carried over from prior years) may offset income and gain is 
made pursuant to Sec.  1.1502-11(b)(2) and (3).
    (ii) Tentative adjustment of stock basis. Second, Sec. Sec.  
1.1502-32 and 1.1502-32T are tentatively applied to adjust the basis of 
the S stock to reflect the amount of S's unlimited deductions and 
losses that are absorbed in the tentative computation of taxable income 
(or loss) for the year of the disposition (and any prior years to which 
the deductions or losses may be carried) that is made pursuant to Sec.  
1.1502-11(b)(2), but not to reflect the realization of excluded COD 
income and the reduction of attributes in respect thereof.
    (iii) Tentative computation of stock gain or loss. Third, in the 
case of a disposition of S stock that does not result from the 
application of Sec.  1.1502-19(c)(1)(iii)(B), P's income, gain, or loss 
from the disposition of S stock is computed. For this purpose, the 
result of the computation pursuant to paragraph (c)(2)(ii) of this 
section is treated as the basis of such stock.
    (iv) Tentative computation of taxable income (or loss). Fourth, 
taxable income (or loss) for the year of disposition (and any prior 
years to which the deductions or losses may be carried) is tentatively 
computed. For this purpose, in the case of a disposition of S stock 
that does not result from the application of Sec.  1.1502-
19(c)(1)(iii)(B), the tentative computation of taxable income (loss) 
takes into account P's income, gain, or loss from the disposition of S 
stock computed pursuant to paragraph (c)(2)(iii) of this section. The 
tentative computation of taxable income (loss) is made without regard 
to whether all or a portion of an excess loss account in a share of S 
is required to be taken into account pursuant to Sec. Sec.  1.1502-
19(c)(1)(iii)(B) and 1.1502-19T(b)(1).
    (v) Tentative reduction of attributes. Fifth, the rules of sections 
108 and 1017 and Sec.  1.1502-28T are tentatively applied to reduce the 
attributes remaining after the tentative computation of taxable income 
(or loss) pursuant to paragraph (c)(2)(iv) of this section.
    (vi) Actual adjustment of stock basis. Sixth, Sec. Sec.  1.1502-32 
and 1.1502-32T are applied to reflect the amount of S's unlimited 
deductions and losses that are absorbed in the tentative computation of 
taxable income (or loss) for the year of the disposition (and any prior 
years to which the deductions or losses may be carried) made pursuant 
to paragraph (c)(2)(iv) of this section, and the excluded COD income 
applied to reduce attributes and the attributes tentatively reduced in 
respect of the excluded COD income pursuant to paragraph (c)(2)(v) of 
this section.
    (vii) Actual computation of stock gain or loss. Seventh, the 
group's actual gain or loss on the disposition of S stock (including a 
disposition that results from the application of Sec.  1.1502-
19(c)(1)(iii)(B)) is computed. The result of the computation pursuant 
to paragraph (c)(2)(vi) of this section is treated as the basis of such 
stock.
    (viii) Actual computation of taxable income (or loss). Eighth, 
taxable income (or loss) for the year of the disposition (and any prior 
years to which the deductions or losses may be carried) is computed. 
The group's actual consolidated taxable income (or loss) for the year 
of the disposition is computed by applying the limitation computed 
pursuant to paragraph (c)(2)(i) of this section, and by including the 
gain or loss recognized on the disposition of S stock computed pursuant 
to paragraph (c)(2)(vii) of this section. However, attributes that were 
tentatively used to offset income pursuant to paragraph (c)(2)(iv) of 
this section and attributes that were tentatively reduced pursuant to 
paragraph (c)(2)(v) of this section cannot offset any excess loss 
account taken into account as a result of the application of Sec. Sec.  
1.1502-19(c)(1)(iii)(B) and 1.1502-19T(b)(1).
    (ix) Actual reduction of attributes. Ninth, the rules of sections 
108 and 1017 and Sec.  1.1502-28T are actually applied to reduce the 
attributes remaining after the actual computation of taxable income (or 
loss) pursuant to paragraph (c)(2)(viii) of this section.
    (A) S or a lower-tier corporation realizes excluded COD income. If 
S or a lower-tier corporation of S realizes excluded COD income, the 
aggregate amount of excluded COD income that is applied to reduce 
attributes attributable to members other than S and any lower-tier 
corporation of S pursuant to this paragraph (c)(2)(ix) shall not exceed 
the aggregate amount of excluded COD income that was tentatively 
applied to reduce attributes attributable to members other than S and 
any lower-tier corporation of S pursuant to paragraph (c)(2)(v) of this 
section. The amount of the actual reduction of attributes attributable 
to S and any lower-tier corporation of S that may be reduced in respect 
of the excluded COD income of S or a lower-tier corporation of S shall 
not be so limited.
    (B) A member other than S or a lower-tier corporation realizes 
excluded COD income. If a member other than S or a lower-tier 
corporation of S realizes excluded COD income, the aggregate amount of 
excluded COD income that is applied to reduce attributes (other than 
credits) attributable to S and any lower-tier corporation of S pursuant 
to this paragraph (c)(2)(ix) shall not exceed the aggregate amount of 
excluded COD income that was tentatively applied to reduce attributes 
(other than credits) attributable to S and any lower-tier corporation 
of S pursuant to paragraph (c)(2)(v) of this section. The amount of the 
actual reduction of attributes attributable to any member other than S 
and any lower-tier corporation of S that may be reduced in respect of 
the excluded COD income of S or a lower-tier corporation of S shall not 
be so limited.
    (3) Special rules. (i) If the reduction of attributes attributable 
to a member is prevented as a result of a limitation described in 
paragraph (c)(2)(ix)(B) of this section, the excluded COD income that 
would have otherwise been applied to reduce such attributes is applied 
to reduce the remaining attributes of the same type that are available 
for reduction under Sec.  1.1502-28T(a)(4), on a pro rata basis, prior 
to reducing attributes of a different type. The reduction of such 
remaining attributes, however, is subject to any applicable limitation 
described in paragraph (c)(2)(ix)(B) of this section.
    (ii) To the extent S's deductions and losses in the year of 
disposition (or those of a lower-tier corporation of S) cannot offset 
income or gain because of the limitation under paragraph (b) of this 
section or this paragraph (c) and are not reduced pursuant to sections 
108 and 1017 and Sec.  1.1502-28T, such items are carried to other 
years under the applicable provisions of the Internal Revenue Code and 
regulations as if they were the only items incurred by S (or a

[[Page 12095]]

lower-tier corporation of S) in the year of disposition. For example, 
to the extent S incurs an operating loss in the year of disposition 
that is limited and is not reduced pursuant to section 108 and Sec.  
1.1502-28T, the loss is treated as a separate net operating loss 
attributable to S arising in that year.
    (4) Definition of lower-tier corporation. A corporation is a lower-
tier corporation of S if all of its items of income, gain, deduction, 
and loss (including the absorption of deduction or loss and the 
reduction of attributes other than credits) would be fully reflected in 
P's basis in S's stock under Sec.  1.1502-32.
    (5) Examples. For purposes of the examples in this paragraph (c), 
unless otherwise stated, the tax year of all persons is the calendar 
year, all persons use the accrual method of accounting, the facts set 
forth the only corporate activity, all transactions are between 
unrelated persons, tax liabilities are disregarded, and no election 
under section 108(b)(5) is made. The principles of this paragraph (c) 
are illustrated by the following examples:

    Example 1. Departing member realizes excluded COD income. (i) 
Facts. P owns all of S's stock with a $90 basis. For Year 1, P has 
ordinary income of $30, and S has an $80 ordinary loss and $100 of 
excluded COD income from the discharge of non-intercompany 
indebtedness. P sells the S stock for $20 at the close of Year 1. As 
of the beginning of Year 2, S has Asset A with a basis of $0 and a 
fair market value of $10.
    (ii) Analysis. The steps used to compute the group's 
consolidated taxable income, to effect the reduction of attributes, 
and to compute the limitations on the use and reduction of 
attributes are as follows:
    (A) Computation of limitation on deductions and losses to offset 
income or gain. To determine the amount of the limitation under 
paragraph (c)(2)(i) of this section on S's loss and the effect of 
the absorption of S's loss on P's basis in S's stock under Sec.  
1.1502-32(b), P's gain or loss from the disposition of S's stock is 
not taken into account. The group is tentatively treated as having a 
consolidated net operating loss of $50 (P's $30 of income minus S's 
$80 loss). Under the principles of Sec.  1.1502-21T(b)(2)(iv), all 
of such loss is attributable to S.
    (B) Tentative adjustment of stock basis. Then, pursuant to 
paragraph (c)(2)(ii) of this section, Sec. Sec.  1.1502-32 and 
1.1502-32T are tentatively applied to adjust the basis of S stock. 
For this purpose, however, adjustments attributable to the excluded 
COD income and the reduction of attributes in respect thereof are 
not taken into account. Under Sec.  1.1502-32(b), the absorption of 
$30 of S's loss decreases P's basis in S's stock by $30 to $60.
    (C) Tentative computation of stock gain or loss. Then, P's 
income, gain, or loss from the sale of S stock is computed pursuant 
to paragraph (c)(2)(iii) of this section using the basis computed in 
the previous step. Thus, P is treated as recognizing a $40 loss from 
the sale of S stock.
    (D) Tentative computation of taxable income (or loss). Pursuant 
to paragraph (c)(2)(iv) of this section, taxable income (or loss) 
for the year of disposition (and any prior years to which the 
deductions or losses may be carried) is then tentatively computed, 
taking into account P's $40 loss on the sale of the S stock computed 
pursuant to paragraph (c)(2)(iii) of this section. The group has a 
$50 consolidated net operating loss for Year 1 that, under the 
principles of Sec.  1.1502-21T(b)(2)(iv), is wholly attributable to 
S and a consolidated capital loss of $40 that, under the principles 
of Sec.  1.1501-21T(b)(2)(iv), is wholly attributable to P.
    (E) Tentative reduction of attributes. Next, pursuant to 
paragraph (c)(2)(v) of this section, the rules of sections 108 and 
1017 and Sec.  1.1502-28T are tentatively applied to reduce 
attributes remaining after the tentative computation of taxable 
income (or loss). Pursuant to Sec.  1.1502-28T(a)(2), the tax 
attributes attributable to S would first be reduced to take into 
account its $100 of excluded COD income. Accordingly, the 
consolidated net operating loss for Year 1 would be reduced by $50 
to $0. Then, pursuant to Sec.  1.1502-28T(a)(4), S's remaining $50 
of excluded COD income would reduce the consolidated capital loss 
attributable to P of $40 by $40 to $0. The remaining $10 of excluded 
COD income would have no effect.
    (F) Actual adjustment of stock basis. Pursuant to paragraph 
(c)(2)(vi) of this section, Sec. Sec.  1.1502-32 and 1.1502-32T are 
applied to reflect the amount of S's unlimited deductions and losses 
that are absorbed in the tentative computation of taxable income (or 
loss) for the year of the disposition (and any prior years to which 
the deductions or losses may be carried) and the excluded COD income 
tentatively applied to reduce attributes and the attributes reduced 
in respect of the excluded COD income pursuant to the previous step. 
Under Sec.  1.1502-32(b), the absorption of $30 of S's loss, the 
application of $90 of S's excluded COD income to reduce attributes 
of P and S, and the reduction of the $50 loss attributable to S in 
respect of the excluded COD income results in a positive adjustment 
of $10 to P's basis in the S stock. P's basis in the S stock, 
therefore, is $100.
    (G) Actual computation of stock gain or loss. Pursuant to 
paragraph (c)(2)(vii) of this section, P's actual gain or loss on 
the sale of the S stock is computed using the basis computed in the 
previous step. Accordingly, P recognizes an $80 loss on the 
disposition of the S stock.
    (H) Actual computation of taxable income (or loss). Pursuant to 
paragraph (c)(2)(viii) of this section, taxable income (or loss) is 
computed by taking into account P's $80 loss from the sale of S 
stock. Before the application of Sec.  1.1502-28T, the group, 
therefore, has a consolidated net operating loss of $50 that is 
wholly attributable to S under the principles of Sec.  1.1502-
21T(b)(2)(iv), and a consolidated capital loss of $80 that is wholly 
attributable to P under the principles of Sec.  1.1502-
21T(b)(2)(iv).
    (I) Actual reduction of attributes. Pursuant to paragraph 
(c)(2)(ix) of this section, sections 108 and 1017 and Sec.  1.1502-
28T are then actually applied to reduce attributes remaining after 
the actual computation of taxable income (or loss). Pursuant to 
section 108(b)(4)(B) and Sec.  1.1502-28T(a), the consolidated net 
operating loss attributable to S under the principles of Sec.  
1.1502-21T(b)(2)(iv) is reduced first. Accordingly, the operating 
loss for Year 1 that S would otherwise carry forward is reduced by 
$50 to $0. Then, pursuant to Sec.  1.1502-28T(a)(4), S's remaining 
$50 of excluded COD income reduces consolidated tax attributes. In 
particular, without regard to the limitation imposed by paragraph 
(c)(2)(ix)(A) of this section, the $80 consolidated capital loss, 
which under the principles of Sec.  1.1502-21T(b)(2)(iv) is 
attributable to P, would be reduced by $50 from $80 to $30. However, 
the limitation imposed by paragraph (c)(2)(ix)(A) of this section 
prevents the reduction of the consolidated capital loss attributable 
to P by more than $40. Therefore, the consolidated capital loss 
attributable to P is reduced by only $40 in respect of S's excluded 
COD income. The remaining $10 of excluded COD income has no effect.
    Example 2. Member other than departing member realizes excluded 
COD income. (i) Facts. P owns all of S1's and S2's stock. P's basis 
in S2's stock is $600. For Year 1, P has ordinary income of $30, S1 
has a $100 ordinary loss and $100 of excluded COD income from the 
discharge of non-intercompany indebtedness, and S2 has $200 of 
ordinary loss. P sells the S2 stock for $600 at the close of Year 1. 
As of the beginning of Year 2, S1 has Asset A with a basis of $0 and 
a fair market value of $10.
    (ii) Analysis. The steps used to compute the group's 
consolidated taxable income, to effect the reduction of attributes, 
and to compute the limitations on the use and reduction of 
attributes are as follows:
    (A) Computation of limitation on deductions and losses to offset 
income or gain. To determine the amount of the limitation under 
paragraph (c)(2)(i) of this section on S2's loss and the effect of 
the absorption of S2's loss on P's basis in S2's stock under Sec.  
1.1502-32(b), P's gain or loss from the sale of S2 stock is not 
taken into account. The group is tentatively treated as having a 
consolidated net operating loss of $270 (P's $30 of income minus 
S1's $100 loss and S2's $200 loss). Consequently, $20 of S2's loss 
from Year 1 is unlimited and $180 of S2's loss from Year 1 is 
limited under paragraph (c)(2)(i) of this section.
    (B) Tentative adjustment of stock basis. Then, pursuant to 
paragraph (c)(2)(ii) of this section, Sec. Sec.  1.1502-32 and 
1.1502-32T are tentatively applied to adjust the basis of S2 stock. 
For this purpose, however, adjustments to the basis of S2 stock 
attributable to the reduction of attributes in respect of S1's 
excluded COD income are not taken into account. Under Sec.  1.1502-
32(b), the absorption of $20 of S2's loss decreases P's basis in 
S2's stock by $20 to $580.
    (C) Tentative computation of stock gain or loss. Then, P's 
income, gain, or loss from the disposition of S2 stock is computed 
pursuant to paragraph (c)(2)(iii) of this section using the basis 
computed in the previous step. Thus, P is treated as recognizing a 
$20 gain from the sale of the S2 stock.

[[Page 12096]]

    (D) Tentative computation of taxable income (or loss). Pursuant 
to paragraph (c)(2)(iv) of this section, taxable income (or loss) 
for the year of disposition (and any prior years to which the 
deductions or losses may be carried) is then tentatively computed, 
taking into account P's $20 gain from the sale of S2 stock. P's $20 
gain from the sale of S2's stock is offset by $20 of S1's loss. 
Therefore, the group is tentatively treated as having a consolidated 
net operating loss of $250, $70 of which is attributable to S1 and 
$180 of which is attributable to S2 under the principles of Sec.  
1.1502-21T(b)(2)(iv).
    (E) Tentative reduction of attributes. Next, pursuant to 
paragraph (c)(2)(v) of this section, the rules of sections 108 and 
1017 and Sec.  1.1502-28T are tentatively applied to reduce 
attributes remaining after the tentative computation of taxable 
income (or loss). Pursuant to Sec.  1.1502-28T(a)(2), the tax 
attributes attributable to S1 would first be reduced to take into 
account its $100 of excluded COD income. Accordingly, the 
consolidated net operating loss for Year 1 would be reduced by $70, 
the portion of the consolidated net operating loss attributable to 
S1 under the principles of Sec.  1.1502-21T(b)(2)(iv), to $0. Then, 
pursuant to Sec.  1.1502-28T(a)(4), S1's remaining $30 of excluded 
COD income would reduce the consolidated net operating loss 
attributable to S2 of $180 by $30 to $150.
    (F) Actual adjustment of stock basis. Pursuant to paragraph 
(c)(2)(vi) of this section, Sec. Sec.  1.1502-32 and 1.1502-32T are 
applied to reflect the amount of S2's unlimited deductions and 
losses that are absorbed in the tentative computation of taxable 
income (or loss) for the year of the disposition (and any prior 
years to which the deductions or losses may be carried) and the 
excluded COD income tentatively applied to reduce attributes and the 
attributes reduced in respect of the excluded COD income pursuant to 
the previous step. Under Sec.  1.1502-32(b), the absorption of $20 
of S2's loss and the application of $30 of S1's excluded COD income 
to reduce attributes attributable to S2 results in a negative 
adjustment of $50 to P's basis in the S2 stock. P's basis in the S2 
stock, therefore, is $550.
    (G) Actual computation of stock gain or loss. Pursuant to 
paragraph (c)(2)(vii) of this section, P's actual gain or loss on 
the sale of the S2 stock is computed using the basis computed in the 
previous step. Therefore, P recognizes a $50 gain on the disposition 
of the S2 stock.
    (H) Actual computation of taxable income (or loss). Pursuant to 
paragraph (c)(2)(viii) of this section, taxable income (or loss) is 
computed by taking into account P's $50 gain from the disposition of 
the S2 stock. Before the application of Sec.  1.1502-28T, therefore, 
the group has a consolidated net operating loss of $220, $40 of 
which is attributable to S1 and $180 of which is attributable to S2 
under the principles of Sec.  1.1502-21T(b)(2)(iv).
    (I) Actual reduction of attributes. Pursuant to paragraph 
(c)(2)(ix) of this section, sections 108 and 1017 and Sec.  1.1502-
28T are then actually applied to reduce attributes remaining after 
the actual computation of taxable income (or loss). Pursuant to 
Sec.  1.1502-28T(a)(2), the tax attributes attributable to S1 must 
first be reduced to take into account its $100 of excluded COD 
income. Accordingly, pursuant to section 108(b)(4)(B) and Sec.  
1.1502-28T(a), the net operating loss attributable to S1 under the 
principles of Sec.  1.1502-21T(b)(2)(iv) is reduced first. The 
consolidated net operating loss for Year 1 is reduced by $40, the 
portion of the consolidated net operating loss attributable to S1 
under the principles of Sec.  1.1502-21T(b)(2)(iv), to $0. Then, 
pursuant to Sec.  1.1502-28T(a)(4), without regard to the limitation 
imposed by paragraph (c)(2)(ix)(B) of this section, S1's remaining 
$60 of excluded COD income would reduce S2's net operating loss of 
$180 to $120. However, the limitation imposed by paragraph 
(c)(2)(ix)(B) of this section prevents the reduction of S2's loss by 
more than $30. Therefore, S2's loss of $180 is reduced by $30 to 
$150 in respect of S1's excluded COD income. The remaining $30 of 
excluded COD income has no effect.
    Example 3. Lower-tier corporation of departing member realizes 
excluded COD income. (i) Facts. P owns all of S1's stock, S2's 
stock, and S3's stock. S1 owns all of S4's stock. P's basis in S1's 
stock is $50 and S1's basis in S4 stock is $50. For Year 1, P has 
$50 of ordinary loss, S1 has $100 of ordinary loss, S2 has $150 of 
ordinary loss, S3 has $50 of ordinary loss, and S4 has $50 of 
ordinary loss and $80 of excluded COD income from the discharge of 
non-intercompany indebtedness. P sells the S1 stock for $100 at the 
close of Year 1. As of the beginning of Year 2, S4 has Asset A with 
a basis of $0 and a fair market value of $10.
    (ii) Analysis. The steps used to compute the group's 
consolidated taxable income, to effect the reduction of attributes, 
and to compute the limitations on the use and reduction of 
attributes are as follows:
    (A) Computation of limitation on deductions and losses to offset 
income or gain. To determine the amount of the limitation under 
paragraph (c)(2)(i) of this section on S1's and S4's losses and the 
effect of the absorption of S1's and S4's losses on P's basis in 
S1's stock under Sec.  1.1502-32(b), P's gain or loss from the 
disposition of S1's stock is not taken into account. The group is 
tentatively treated as having a consolidated net operating loss of 
$400. Consequently, $100 of S1's loss and $50 of S4's loss is 
limited under paragraph (c)(2)(i) of this section.
    (B) Tentative adjustment of stock basis. Then, pursuant to 
paragraph (c)(2)(ii) of this section, Sec. Sec.  1.1502-32 and 
1.1502-32T are tentatively applied to adjust the basis of S stock. 
For this purpose, adjustments to the basis of S1 stock attributable 
to S4's realization of excluded COD income and the reduction of 
attributes in respect of such excluded COD income are not taken into 
account. There is no adjustment under Sec.  1.1502-32 to the basis 
of the S1 stock. Therefore, P's basis in the S1 stock for this 
purpose is $50.
    (C) Tentative computation of stock gain or loss. Then, P's 
income, gain, or loss from the sale of S1 stock is computed pursuant 
to paragraph (c)(2)(iii) of this section using the basis computed in 
the previous step. Thus, P is treated as recognizing a $50 gain from 
the sale of the S1 stock.
    (D) Tentative computation of taxable income (or loss). Pursuant 
to paragraph (c)(2)(iv) of this section, taxable income (or loss) 
for the year of disposition (and any prior years to which the 
deductions or losses may be carried) is tentatively computed, taking 
into account P's $50 gain from the sale of the S1 stock computed 
pursuant to the previous step. P's $50 gain from the sale of the S1 
stock is offset by $10 of P's loss, $30 of S2's loss, and $10 of 
S3's loss. Therefore, the group is tentatively treated as having a 
consolidated net operating loss of $350, $40 of which is 
attributable to P, $100 of which is attributable to S1, $120 of 
which is attributable to S2, $40 of which is attributable to S3, and 
$50 of which is attributable to S4 under the principles of Sec.  
1.1502-21T(b)(2)(iv).
    (E) Tentative reduction of attributes. Next, pursuant to 
paragraph (c)(2)(v) of this section, the rules of sections 108 and 
1017 and Sec.  1.1502-28T are tentatively applied to reduce 
attributes remaining after the tentative computation of taxable 
income (or loss). Pursuant to Sec.  1.1502-28T(a)(2), the tax 
attributes attributable to S4 would first be reduced to take into 
account its excluded COD income in the amount of $100. Accordingly, 
the consolidated net operating loss attributable to S4 would be 
reduced by $50 to $0. Then, pursuant to Sec.  1.1502-28T(a)(4), S4's 
remaining $30 of excluded COD income would reduce the consolidated 
net operating loss for Year 1 that is attributable to other members. 
Therefore, the consolidated net operating loss for Year 1 would be 
reduced by $30. Of that amount, $4 is attributable to P, $10 is 
attributable to S1, $12 is attributable to S2, and $4 is 
attributable to S3.
    (F) Actual adjustment of stock basis. Pursuant to paragraph 
(c)(2)(vi) of this section, Sec. Sec.  1.1502-32 and 1.1502-32T are 
applied to reflect the amount of S1's and S4's unlimited deductions 
and losses that are absorbed in the tentative computation of taxable 
income (or loss) for the year of the disposition (and any prior 
years to which the deductions or losses may be carried) and the 
excluded COD income tentatively applied to reduce attributes and the 
attributes reduced in respect of the excluded COD income pursuant to 
the previous step. Under Sec.  1.1502-32(b), the application of $80 
of S4's excluded COD income to reduce attributes, and the reduction 
of S4's loss in the amount of $50 and S1's loss in the amount of $10 
in respect of the excluded COD income results in a positive 
adjustment of $20 to P's basis in the S1 stock. Accordingly, P's 
basis in S1 stock is $70.
    (G) Actual computation of stock gain or loss. Pursuant to 
paragraph (c)(2)(vii) of this section, P's actual gain or loss on 
the sale of the S1 stock is computed using the basis computed in the 
previous step. Accordingly, P recognizes a $30 gain on the 
disposition of the S1 stock.
    (H) Actual computation of taxable income (or loss). Pursuant to 
paragraph (c)(2)(viii) of this section, the group's taxable income 
or loss is then computed by taking into account P's $30 gain from 
the sale of S1 stock. Before the application of Sec.  1.1502-28T, 
therefore, the group has a consolidated net operating

[[Page 12097]]

loss of $370, $44 of which is attributable to P, $100 of which is 
attributable to S1, $132 of which is attributable to S2, $44 of 
which is attributable to S3, and $50 of which is attributable to S4.
    (I) Actual reduction of attributes. Pursuant to paragraph 
(c)(2)(ix) of this section, sections 108 and 1017 and Sec.  1.1502-
28T are then actually applied to reduce attributes remaining after 
the actual computation of taxable income (or loss). Pursuant to 
Sec.  1.1502-28T(a)(2), the tax attributes attributable to S4 must 
first be reduced to take into account its $80 of excluded COD 
income. Accordingly, the consolidated net operating loss 
attributable to S4 is reduced by $50 to $0. Then, pursuant to Sec.  
1.1502-28T(a)(4), S4's remaining $30 of excluded COD income reduces 
the consolidated net operating loss for Year 1. Therefore, without 
regard to the limitation imposed by paragraph (c)(2)(ix)(B) of this 
section, the consolidated net operating loss for Year 1 would be 
reduced by $30 ($4.12 of the consolidated net operating loss 
attributable to P, $9.38 of the consolidated net operating loss 
attributable to S1, $12.38 of the consolidated net operating loss 
attributable to S2, and $4.12 of the consolidated net operating loss 
attributable to S3) to $290. However, the limitation imposed by 
paragraph (c)(2)(ix)(B) of this section prevents the reduction of 
the consolidated net operating loss attributable to P, S2, and S3 by 
more than $4, $12, and $4 respectively. The $.62 of excluded COD 
income that would have otherwise reduced the consolidated net 
operating loss attributable to P, S2, and S3 is applied to reduce 
the consolidated net operating loss attributable to S1. Therefore, 
S1 carries forward $90 of loss.
    Example 4. Excess loss account taken into account. (i) Facts. P 
is the common parent of a consolidated group. On Day 1 of Year 2, P 
acquired all of the stock of S1. As of the beginning of Year 2, S1 
had a $30 net operating loss carryover from Year 1, a separate 
return limitation year. A limitation under Sec.  1.1502-21(c) 
applies to the use of that loss by the P group. For Years 1 and 2, 
the P group had no consolidated taxable income or loss. On Day 1 of 
Year 3, S1 acquired all of the stock of S2 for $10. In Year 3, P had 
ordinary income of $10, S1 had ordinary income of $25, and S2 had an 
ordinary loss of $50. In addition, in Year 3, S2 realized $20 of 
excluded COD income from the discharge of non-intercompany 
indebtedness. After the discharge of this indebtedness, S2 had no 
liabilities. As of the beginning of Year 4, S2 had Asset A with a 
basis of $0 and a fair market value of $10. S2 had no taxable income 
(or loss) for Year 1 and Year 2.
    (ii) Analysis. The steps used to compute the group's 
consolidated taxable income, to effect the reduction of attributes, 
and to compute the limitations on the use and reduction of 
attributes are as follows:
    (A) Computation of limitation on deduction and losses to offset 
income or gain, tentative basis adjustments, tentative computation 
of stock gain or loss. Because it is not initially apparent that 
there has been a disposition of stock, paragraph (c)(2)(i) of this 
section does not limit the use of deductions to offset income or 
gain, no adjustments to the basis are required pursuant to paragraph 
(c)(2)(ii) of this section, and no stock gain or loss is computed 
pursuant to paragraph (c)(2)(iii) of this section or taken into 
account in the tentative computation of taxable income pursuant to 
paragraph (c)(2)(iv) of this section.
    (B) Tentative computation of taxable income (or loss). Pursuant 
to paragraph (c)(2)(iv) of this section, the group's taxable income 
(or loss) for Year 3 (and any prior years to which the deductions or 
losses may be carried) is tentatively computed. For Year 3, the P 
group has a consolidated taxable loss of $15, all of which is 
attributable to S2 under the principles of Sec.  1.1502-
21T(b)(2)(iv).
    (C) Tentative reduction of attributes. Next, pursuant to 
paragraph (c)(2)(v) of this section, the rules of sections 108 and 
1017 and Sec. Sec.  1.1502-28T are tentatively applied to reduce 
attributes remaining after the tentative computation of consolidated 
taxable loss. Pursuant to Sec.  1.1502-28T(a)(2), the tax attributes 
attributable to S2 would first be reduced to take into account its 
excluded COD income of $20. Accordingly, the net operating loss 
attributable to S2 under the principles of Sec.  1.1502-
21T(b)(2)(iv) is reduced first. Therefore, the consolidated net 
operating loss for Year 3 is reduced by $15, the portion of the 
consolidated net operating loss attributable to S2, to $0. The 
remaining $5 of excluded COD income is not applied to reduce 
attributes as there are no remaining attributes that are subject to 
reduction.
    (D) Actual adjustment of stock basis. Pursuant to paragraph 
(c)(2)(vi) of this section, Sec. Sec.  1.1502-32 and 1.1502-32T are 
applied to reflect the amount of S2's unlimited deductions and 
losses that are absorbed in the tentative computation of taxable 
income (or loss) for the year of the disposition (and any prior 
years to which the deductions or losses may be carried) and the 
excluded COD income tentatively applied to reduce attributes and the 
attributes reduced in respect of the excluded COD income pursuant to 
the previous step. Pursuant to Sec. Sec.  1.1502-32 and 1.1502-32T, 
the absorption of $35 of S2's loss, the application of $15 in 
respect of S2's excluded COD income to reduce attributes, and the 
reduction of $15 in respect of the loss attributable to S2 reduced 
in respect of the excluded COD income results in a negative 
adjustment of $35 to the basis of the S2 stock. Therefore, S1 has an 
excess loss account of $25 in the S2 stock.
    (E) Actual computation of stock gain or loss. Pursuant to 
paragraph (c)(2)(vii) of this section, S1's actual gain or loss, if 
any, on the S2 stock is computed. Because S2 realized $5 of excluded 
COD income that was not applied to reduce attributes, pursuant to 
Sec. Sec.  1.1502-19(c)(1)(iii)(B) and 1.1502-19T(b)(1), S1 is 
required to take into account $5 of its excess loss account in the 
S2 stock.
    (F) Actual computation of taxable income (or loss). Pursuant to 
paragraph (c)(2)(viii) of this section, the group's taxable income 
or loss is computed taking into account the $5 of the excess loss 
account in the S2 stock required to be taken into account. See Sec.  
1.1502-28T(b)(6) (requiring an excess loss account that is required 
to be taken into account as a result of the application of Sec.  
1.1502-19(c)(1)(iii)(B) to be included in the group's consolidated 
taxable income for the year that includes the date of the debt 
discharge). However, pursuant to paragraph (c)(2)(viii) of this 
section, such amount may not be offset by any of the consolidated 
net operating loss attributable to S2. It may, however, subject to 
applicable limitations, be offset by the separate net operating loss 
of S1 from Year 1.
    (G) Actual reduction of attributes. Pursuant to paragraph 
(c)(2)(ix) of this section, sections 108 and 1017 and Sec.  1.1502-
28T are then actually applied to reduce attributes remaining after 
the actual computation of taxable income (or loss). Attributes will 
be actually reduced in the same way that they were tentatively 
reduced.

    (6) Additional rules for multiple dispositions. [Reserved]
    (7) Effective date. This paragraph (c) applies to dispositions of 
subsidiary stock that occur after the date these regulations are 
published as temporary or final regulations in the Federal Register. 
Taxpayers may apply this paragraph (c), as contained in these proposed 
regulations, in whole, but not in part, to any disposition of 
subsidiary stock that occurs before the date these regulations are 
published as temporary or final regulations in the Federal Register.
    Par. 3. Section 1.1502-13 is revised to read as follows:


Sec.  1.1502-13  Intercompany transactions.

    [The text of this proposed section is the same as the text of Sec.  
1.1502-13T(g)(3)(ii)(B) published elsewhere in this issue of the 
Federal Register].
    Par. 4. Section 1.1502-28 is amended as follows:
    1. Adding paragraphs (b)(4), (b)(5), (b)(6) and (b)(7).
    2. Revising paragraph (d).
    3. The additions and revision read as follows:


1.1502-28  Consolidated section 108.

* * * * *
    (b)(4) and (5) [The text of paragraphs (b)(4) and(5) is the same as 
the text of Sec.  1.1502-28T(b)(4) and (5) published elsewhere in this 
issue of the Federal Register].
    (6) Taking into account of excess loss account--(i) Determination 
of inclusion. The determination of whether any portion of an excess 
loss account in a share of stock of a subsidiary that realizes excluded 
COD income is required to be taken into account as a result of the 
application of Sec.  1.1502-19(c)(1)(iii)(B) is made after the 
determination of taxable income (or loss) for the year during which the 
member realizes excluded COD income (without regard to whether any 
portion

[[Page 12098]]

of an excess loss account in a share of the subsidiary is required to 
be taken into account) and any prior years to which the deductions or 
losses of the subsidiary may be carried, after the reduction of tax 
attributes pursuant to sections 108 and 1017, and this section, and 
after the adjustment of the basis of the share of stock of the 
subsidiary pursuant to Sec.  1.1502-32 to reflect the amount of the 
subsidiary's deductions and losses that are absorbed in the computation 
of taxable income (or loss) for the year of the disposition and any 
prior years to which the deductions or losses may be carried, and the 
excluded COD income applied to reduce attributes and the attributes 
reduced in respect thereof. See Sec.  1.1502-11(c) for special rules 
related to the computation of taxable income (or loss) that apply when 
an excess loss account is required to be taken into account.
    (ii) [The text of paragraph (b)(6)(ii) is the same as the text of 
Sec.  1.1502-28T(b)(6)(ii) published elsewhere in this issue of the 
Federal Register].
* * * * *
    (7) Dispositions of stock. See Sec.  1.1502-11(c) for limitations 
on the reduction of tax attributes when a member disposes of stock of 
another member (including dispositions that result from the application 
of Sec.  1.1502-19(c)(1)(iii)(B)) during a taxable year in which any 
member realizes excluded COD income.
* * * * *
    (d) Effective dates. (1) This section, other than paragraphs 
(a)(4), (b)(4), (b)(5), (b)(6), and (b)(7) of this section, applies to 
discharges of indebtedness that occur after August 29, 2003.
    (2) Paragraph (a)(4) of this section applies to discharges of 
indebtedness that occur after August 29, 2003, but only if the 
discharge occurs during a taxable year the original return for which is 
due (without regard to extensions) after December 11, 2003. However, 
groups may apply paragraph (a)(4) of this section to discharges of 
indebtedness that occur after August 29, 2003, and during a taxable 
year the original return for which is due (without regard to 
extensions) on or before December 11, 2003. For discharges of 
indebtedness that occur after August 29, 2003, and during a taxable 
year the original return for which is due (without regard to 
extensions) on or before December 11, 2003, paragraph (a)(4) of this 
section shall apply as in effect on August 29, 2003.
    (3) Paragraphs (b)(4), (b)(5), and (b)(6)(ii) of this section apply 
to discharges of indebtedness that occur after August 29, 2003, but 
only if the discharge occurs during a taxable year the original return 
for which is due (without regard to extensions) after March 12, 2004. 
However, groups may apply paragraphs (b)(4), (b)(5), and (b)(6)(ii) of 
this section to discharges of indebtedness that occur after August 29, 
2003, and during a taxable year the original return for which is due 
(without regard to extensions) on or before March 12, 2004.
    (4) Paragraphs (b)(6)(i) and (b)(7) of this section apply to 
discharges of indebtedness that occur after August 29, 2003, but only 
if the discharge occurs during a taxable year the original return for 
which is due (without regard to extensions) after the date these 
regulations are published as temporary or final regulations in the 
Federal Register. However, groups may apply paragraphs (b)(6)(i) and 
(b)(7) of this section to discharges of indebtedness that occur after 
August 29, 2003, and during a taxable year the original return for 
which is due (without regard to extensions) on or before the date these 
regulations are published as temporary or final regulations in the 
Federal Register.
* * * * *
    Par. 5. The last sentence of paragraph (c) of Sec.  1.1502-80 is 
revised to read as follows:


Sec.  1.1502-80  Applicability of other provisions of law.

* * * * *
    (c) * * * See Sec. Sec.  1.1502-11(d) and 1.1502-35T for additional 
rules relating to stock loss.
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-5667 Filed 3-12-04; 8:45 am]
BILLING CODE 4830-01-P