[Federal Register Volume 69, Number 53 (Thursday, March 18, 2004)]
[Rules and Regulations]
[Pages 12799-12802]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-6140]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9118]
RIN 1545-BC84


Loss Limitation Rules

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains amendments relating to certain aspects 
of the temporary regulations addressing the deductibility of losses 
recognized on dispositions of subsidiary stock by members of a 
consolidated group and to the consequences of treating subsidiary stock 
as worthless. In addition, this document contains temporary regulations 
that clarify when stock of a member of a consolidated group may be 
treated as worthless. These regulations apply to corporations filing 
consolidated returns. The text of these 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.

DATES: Effective Date: These regulations are effective March 18, 2004.
    Applicability Date: For dates of applicability see Sec. Sec.  
1.337(d)-2T(g), 1.1502-35T(f) and 1.1502-80T(c).

FOR FURTHER INFORMATION CONTACT: Regarding the amendments under section 
337(d), Mark Weiss (202-622-7790) of the Office of Associate Chief 
Counsel (Corporate), and, regarding the amendments under section 1502, 
Lola L. Johnson (202-622-7550) of the Office of Associate Chief Counsel 
(Corporate) (neither is a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On March 12, 2002, the IRS and Treasury published TD 8984 (67 FR 
11034, 2002-1 C.B. 668), which included temporary regulations under 
sections 337(d) and 1502 that limit the deductibility of loss 
recognized by a consolidated group on the disposition of stock of a 
subsidiary and that require certain basis reductions on the 
deconsolidation of stock of a subsidiary. Those regulations are 
intended to prevent a corporation from avoiding the recognition of gain 
on the disposition of assets through the use of the consolidated return 
regulations.
    Section 1.337(d)-2T disallows loss recognized by a member of a 
consolidated group with respect to the disposition of stock of a 
subsidiary to the extent that such loss is attributable to the 
recognition of built-in gain on the disposition of an asset. For this 
purpose, built-in gain is gain recognized on the disposition of an 
asset to the extent attributable, directly or indirectly, in whole or 
in part, to any excess of value over basis that is reflected, before 
the disposition of the asset, in the basis of the share, directly or 
indirectly, in whole or in part, after applying section 1503(e) and 
other applicable provisions of the Internal Revenue Code and 
regulations.
    On March 14, 2003, the IRS and Treasury published TD 9048 (68 FR 
12287, 2003-13 I.R.B. 645), which included temporary regulations 
generally intended to prevent consolidated groups from obtaining more 
than one tax benefit from a single economic loss. In particular, Sec.  
1.1502-35T(f) of those temporary regulations prescribes rules that are 
intended to prevent groups from obtaining more than one tax benefit 
from a single economic loss when a group member claims a worthless 
stock deduction with respect to stock of a subsidiary. In such cases, 
the regulation requires an apportionment of the group's consolidated 
net operating loss (CNOL) to the subsidiary under the principles of 
Sec.  1.1502-21T(b), and then treats the apportioned losses as expired.
    On August 15, 1994, the IRS and Treasury Department published TD 
8560 (59 FR 41666, 1994-2 C.B. 200) adding paragraph (c) to Sec.  
1.1502-80. Section 1.1502-80(c) provides that, for consolidated return 
years beginning on or after January 1, 1995, stock of a member is not 
treated as worthless under section 165 before the stock is treated as 
disposed of under the principles of Sec.  1.1502-19(c)(1)(iii). Under 
Sec.  1.1502-19(c)(1)(iii), stock of a subsidiary is treated as 
disposed of, by reason of worthlessness, at the time substantially all 
of the subsidiary's assets are treated as disposed of, abandoned, or 
destroyed for Federal income tax purposes, at the time of certain 
discharges of indebtedness of the subsidiary, or at the time a member 
takes into account certain deductions and losses with respect to 
indebtedness of the subsidiary. Section 1.1502-80(c) was promulgated to 
more fully implement the single entity treatment of consolidated 
groups. It also had the effects of preventing certain inappropriate 
disallowances of loss that occurred when Sec.  1.1502-20 governed the 
allowance of stock losses and of alleviating concerns regarding 
protecting the attributes of bankrupt subsidiaries.

Explanation of Provisions

    Taxpayers have raised several questions regarding the 
interpretation and application of Sec. Sec.  1.337(d)-2T, 1.1502-
35T(f), and 1.1502-80(c). The following paragraphs describe these 
questions and the manner in which they are addressed in these temporary 
regulations.

A. Section 1.337(d)-2T

    Taxpayers have questioned whether, in computing the amount of stock 
loss that is attributable to the recognition of built-in gain, gain 
recognized on the disposition of an asset may be reduced by expenses 
directly attributable to the recognition of that gain. The IRS and 
Treasury Department believe that, because expenses attributable to the 
recognition of built-in gain reduce the basis of the subsidiary's 
stock, the computation of the amount of stock loss that is attributable 
to the recognition of built-in gain should take such expenses into 
account. Accordingly, this document amends Sec.  1.337(d)-2T to provide 
that stock loss is not disallowed to the extent the taxpayer 
establishes that the loss or basis is not attributable to recognized 
built-in gain reduced by expenses directly related to the

[[Page 12800]]

recognition of that gain, including, in certain cases, Federal income 
taxes related to the recognition of such gain. In addition, this 
document makes a non-substantive technical correction to the example 
set forth in Sec.  1.337(d)-2T(c)(4).
    The IRS and Treasury Department continue to consider alternative 
methods of implementing section 337(d) in the consolidated return 
context.

B. Section 1.1502-35T(f)

    Taxpayers have commented that, in certain cases, Sec.  1.1502-
35T(f) may eliminate losses where there is no risk of duplication. In 
particular, taxpayers are concerned that the rule appears to eliminate 
a subsidiary's apportioned part of the CNOL even if the subsidiary has 
a separate return year following the year in which a member of the 
group claims a worthless stock deduction with respect to the 
subsidiary's stock. The IRS and Treasury Department believe that the 
elimination of a subsidiary's apportioned CNOL is generally necessary 
to prevent duplication only if a member of the group claims a worthless 
stock deduction with respect to subsidiary stock and the subsidiary has 
no separate return year following the year in which the worthless stock 
deduction is claimed. These temporary regulations, therefore, amend 
Sec.  1.1502-35T(f) to provide that the subsidiary's apportioned part 
of the CNOL is treated as expired if a member (the claiming member) 
claims a worthless stock deduction with respect to the subsidiary's 
stock and, immediately following the taxable year in which the 
worthless stock deduction is claimed, the subsidiary is a member of a 
group that includes any corporation (other than a lower-tier subsidiary 
of the member the stock of which was treated as worthless) that, during 
that taxable year, was a member of the group that includes the claiming 
member.
    The IRS and the Treasury Department continue to consider methods of 
preventing groups from obtaining more than a single tax benefit from a 
single economic loss other than the methods employed in Sec.  1.1502-
35T.

C. Section 1.1502-80(c)

    Taxpayers have also raised concerns that, in certain circumstances, 
Sec.  1.1502-80(c) may prevent a group from claiming a worthless stock 
deduction with respect to subsidiary stock that is worthless within the 
meaning of section 165 if the subsidiary ceases to be a member of the 
group before it satisfies the requirements of Sec.  1.1502-
19(c)(1)(iii). For example, assume that the stock of a subsidiary is 
worthless within the meaning of section 165 but the subsidiary has not 
disposed of, abandoned, or destroyed substantially all of its assets 
and the requirements of Sec.  1.1502-19(c)(1)(iii) are not otherwise 
satisfied. At that time, Sec.  1.1502-80(c) would prevent the group 
from treating the subsidiary's stock as worthless. If the subsidiary 
then cancels its outstanding shares and issues new shares to its 
creditors, which are not members of the group, the subsidiary will 
cease to be a member of the group before it satisfies the requirements 
of Sec.  1.1502-80(c). Taxpayers are concerned that, unless Sec.  
1.1502-80(c) is treated as inapplicable immediately prior to the 
cancellation of the subsidiary's stock, the group will never be 
entitled to claim a worthless stock deduction with respect to that 
stock.
    Section 1.1502-80(c) is intended to defer, not disallow, worthless 
stock deductions with respect to subsidiary stock. Therefore, these 
temporary regulations amend Sec.  1.1502-80(c) and add Sec.  1.1502-
80T(c) to clarify that the deferral of an otherwise allowable loss 
under section 165 terminates immediately prior to the time that the 
subsidiary ceases to be a member of the group. Accordingly, in the 
example above, the group would be entitled to the worthless stock 
deduction in the taxable year in which the subsidiary ceases to be a 
member of the group.
    Taxpayers have questioned whether Sec.  1.1502-80(c) remains 
necessary given that Sec.  1.1502-20 no longer governs the allowance of 
loss on sales of subsidiary stock. The IRS and Treasury are evaluating 
whether the rule of Sec.  1.1502-80(c) continues to be necessary or 
appropriate.

Effective Date

    The amendments set forth in these temporary regulations are 
applicable to tax years beginning after March 18, 2004. However, 
taxpayers may apply these temporary regulations to certain prior 
periods.

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 allowable loss and basis reductions in connection with 
dispositions and deconsolidations of subsidiary stock. These temporary 
regulations clarify existing rules and simplify their application in 
order to ease taxpayer compliance. 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)(1) and (3). For the applicability of the Regulatory Flexibility 
Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the 
preamble to the cross-reference notice of proposed rulemaking published 
in 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 its impact on small business.

Drafting Information

    The principal author of the regulations under section 337(d) is 
Mark Weiss, Office of Associate Chief Counsel (Corporate). The 
principal author of the regulations under section 1502 is Lola L. 
Johnson, Office of Associate Chief Counsel (Corporate). However, other 
personnel from the IRS and Treasury participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

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 continues to read in 
part as follows:

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

0
Par. 2. Section 1.337(d)-2T is amended by revising paragraph (c)(2) and 
the example in paragraph (c)(4) to read as follows:


Sec.  1.337(d)-2T  Loss limitation window period (temporary).

* * * * *
    (c) * * *
    (2) General rule. Loss is not disallowed under paragraph (a)(1) of 
this section and basis is not reduced under paragraph (b)(1) of this 
section to the extent the taxpayer establishes that the loss or basis 
is not attributable to the recognition of built-in gain, net of 
directly related expenses, on the disposition of an asset (including 
stock and securities). Loss or basis may be attributable to the 
recognition of built-in gain on the disposition of an asset by a prior 
group. For purposes of this section, gain recognized on the disposition 
of an asset is built-in gain to the extent attributable, directly or 
indirectly, in whole or in part, to any excess of value over basis that 
is reflected, before the disposition of the

[[Page 12801]]

asset, in the basis of the share, directly or indirectly, in whole or 
in part, after applying section 1503(e) and other applicable provisions 
of the Internal Revenue Code and regulations. Federal income taxes may 
be directly related to built-in gain recognized on the disposition of 
an asset only to the extent of the excess (if any) of the group's 
income tax liability actually imposed under Subtitle A of the Internal 
Revenue Code for the taxable year of the disposition of the asset over 
the group's income tax liability for the taxable year redetermined by 
not taking into account the built-in gain recognized on the disposition 
of the asset. For this purpose, the group's income tax liability 
actually imposed and its redetermined income tax liability are 
determined without taking into account the foreign tax credit under 
section 27(a) of the Internal Revenue Code. This paragraph (c)(2) 
applies to dispositions and deconsolidations on or after March 18, 
2004. Taxpayers, however, may choose to apply this paragraph (c)(2) to 
dispositions and deconsolidations on or after March 7, 2002; otherwise, 
paragraph (c)(2) of Sec.  1.337(d)-2T as contained in 26 CFR part 1 
edition revised as of April 1, 2003, shall apply.
* * * * *
    (4) * * *
    Example. Loss offsetting built-in gain in a prior group. (i) P 
buys all the stock of T for $50 in Year 1, and T becomes a member of 
the P group. T has 2 assets. Asset 1 has a basis of $50 and a value 
of $0, and asset 2 has a basis of $0 and a value of $50. T sells 
asset 2 during Year 3 for $50 and recognizes a $50 gain. Under the 
investment adjustment system, P's basis in the T stock increased to 
$100 as a result of the recognition of gain. In Year 5, all of the 
stock of P is acquired by the P1 group, and the former members of 
the P group become members of the P1 group. T then sells asset 1 for 
$0, and recognizes a $50 loss. Under the investment adjustment 
system, P's basis in the T stock decreases to $50 as a result of the 
loss. T's assets decline in value from $50 to $40. P then sells all 
the stock of T for $40 and recognizes a $10 loss.
    (ii) P's basis in the T stock reflects both T's unrecognized gain 
and unrecognized loss with respect to its assets. The gain T recognizes 
on the disposition of asset 2 is built-in gain with respect to both the 
P and P1 groups for purposes of paragraph (c)(2) of this section. In 
addition, the loss T recognizes on the disposition of asset 1 is built-
in loss with respect to the P and P1 groups for purposes of paragraph 
(c)(2) of this section. T's recognition of the built-in loss while a 
member of the P1 group offsets the effect on T's stock basis of T's 
recognition of the built-in gain while a member of the P group. Thus, 
P's $10 loss on the sale of the T stock is not attributable to the 
recognition of built-in gain, and the loss is therefore not disallowed 
under paragraph (c)(2) of this section.
    (iii) The result would be the same if, instead of having a $50 
built-in loss in asset 1 when it becomes a member of the P group, T has 
a $50 net operating loss carryover and the carryover is used by the P 
group.
* * * * *

0
Par. 3. Section 1.1502-35T is amended by revising paragraph (f)(1) to 
read as follows:


Sec.  1.1502-35T  Transfers of subsidiary member stock and 
deconsolidations of subsidiary members (temporary).

* * * * *
    (f) Worthlessness not followed by separate return years--(1) 
General rule. Notwithstanding any other provision in the regulations 
under section 1502, if a member of a group (the claiming group) treats 
stock of a subsidiary as worthless under section 165 (taking into 
account the provisions of Sec.  1.1502-80(c)) and, on the day following 
the last day of the claiming group's taxable year in which the 
worthless stock deduction is claimed, the subsidiary (or its successor, 
determined without regard to paragraphs (d)(5)(iii) and (iv) of this 
section) is a member of a group that includes any corporation that, 
during that taxable year, was a member of the claiming group (other 
than a lower-tier subsidiary of the subsidiary) or is a successor 
(determined without regard to paragraphs (d)(5)(iii) and (iv) of this 
section) of such a member, then all losses treated as attributable to 
the subsidiary under the principles of Sec.  1.1502-21T(b)(2)(iv) shall 
be treated as expired as of the day following the last day of the 
claiming group's taxable year in which the worthless stock deduction is 
claimed. In addition, notwithstanding any other provision in the 
regulations under section 1502, if a member recognizes a loss with 
respect to subsidiary stock and on the following day the subsidiary is 
not a member of the group and does not have a separate return year, 
then all losses treated as attributable to the subsidiary under the 
principles of Sec.  1.1502-21T(b)(2)(iv) shall be treated as expired as 
of the day following the last day of the group's taxable year in which 
the stock loss is claimed. For purposes of this paragraph (f), the 
determination of the losses attributable to the subsidiary shall be 
made after computing the taxable income of the group for the taxable 
year in which the group treats the stock of the subsidiary as worthless 
or the subsidiary liquidates and after computing the taxable income for 
any taxable year to which such losses may be carried back. The loss 
treated as expired under this paragraph (f) shall not be treated as a 
noncapital, nondeductible expense under Sec.  1.1502-32(b)(2)(iii). 
This paragraph (f) applies to worthlessness determinations and 
liquidations that occur after March 18, 2004 and before March 12, 2006. 
However, the group may apply this paragraph (f) to worthlessness 
determinations and liquidations that occur on or after March 7, 2002 
and before March 18, 2004; otherwise, paragraph (f) of Sec.  1.1502-35T 
as contained in 26 CFR part 1 edition revised as of April 1, 2003, 
shall apply to such determinations of worthlessness and liquidations.
* * * * *

0
Par. 4. Section 1.1502-80 is amended by adding a sentence to the end of 
paragraph (c) to read as follows:


1.1502-80  Applicability of other provisions of law.

* * * * *
    (c) * * * For further guidance, see Sec.  1.1502-80T(c).

0
Par. 5. Section 1.1502-80T is added to read as follows:


Sec.  1.1502-80T  Applicability of other provisions of law (temporary).

    (a) and (b) [Reserved]. For further guidance, see Sec.  1.1502-
80(a) and (b).
    (c) Deferral of section 165. Stock of a member is not treated as 
worthless under section 165 before the stock is treated as disposed of 
under the principles of Sec.  1.1502-19(c)(1)(iii). If stock of a 
member would otherwise be treated as worthless under the principles of 
section 165, then, notwithstanding the previous sentence, such stock 
may be treated as worthless under section 165 immediately prior to the 
time such member ceases to be a member of the group. See Sec. Sec.  
1.1502-11(c) and 1.1502-35T for additional rules relating to stock 
loss. This paragraph (c) applies to taxable years beginning after March 
18, 2004 and before March 19, 2007. Taxpayers, however, may apply this 
paragraph (c) to taxable years beginning on or after January 1, 1995 
and before March 18, 2004; otherwise, paragraph (c) of Sec.  1.1502-80 
as contained in 26 CFR part 1 edition revised as of April 1, 2003, 
shall apply to taxable years beginning on or after January 1, 1995, and 
on or before March 18, 2004.

[[Page 12802]]

    (d) through (f) [Reserved]. For further guidance, see Sec.  1.1502-
80(d) through (f).

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: March 9, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-6140 Filed 3-17-04; 8:45 am]
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