[Federal Register Volume 69, Number 245 (Wednesday, December 22, 2004)]
[Rules and Regulations]
[Pages 76612-76614]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-28013]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9170]
RIN 1545-BD99


Section 1374 Effective Dates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: These temporary regulations provide guidance concerning the 
applicability of section 1374 to S corporations that acquire assets in 
carryover basis transactions from C corporations on or after December 
27, 1994, and to certain corporations that terminate S corporation 
status and later elect again to become S corporations. 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.

DATES: Effective Date: These regulations are effective December 22, 
2004.
    Applicability Dates: Section 1.1374-8T applies to any transaction 
described in section 1374(d)(8) that occurs on or after December 27, 
1994. Section 1.1374-10T applies for taxable years beginning after 
December 22, 2004. The applicability of Sec.  1.1374(d)-8T and Sec.  
1.1374(d)-10T will expire on or before December 21, 2007.

FOR FURTHER INFORMATION CONTACT: Stephen R. Cleary; (202) 622-7750, 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

1. Section 1374 and Its Effective Dates

    Under the General Utilities doctrine, see General Utilities & 
Operating Co. v. Helvering, 296 U.S. 200 (1935), a C corporation, in 
certain cases, could distribute appreciated assets to its shareholders 
or sell appreciated assets without recognizing gain. Section 1374 of 
the Internal Revenue Code of 1986 (Code), amended in the Tax Reform Act 
of 1986 (TRA) as part of the repeal of the General Utilities doctrine, 
prevents a corporation from circumventing General Utilities repeal by 
converting to S corporation status before distributing appreciated 
assets to its shareholders or selling appreciated assets.
    Section 1374 generally imposes a corporate level tax on an S 
corporation's net recognized built-in gain attributable to assets that 
it held on the date it converted from a C corporation to an S 
corporation. This tax is imposed on built-in gain recognized during the 
10-year period beginning on the first day the corporation is an S 
corporation. Section 1374(d)(8), which was added by the Technical and 
Miscellaneous Revenue Act of 1988 (TAMRA), imposes a corporate level 
tax on an S corporation's net recognized built-in gain attributable to 
assets that it acquired in a carryover basis transaction from a C 
corporation for the 10-year recognition period beginning on the day of 
the carryover basis transaction.
    Under section 1374(d)(9), which also was added by TAMRA, any 
reference in section 1374 to the first taxable year the corporation was 
an S corporation is a reference to the first taxable year it was an S 
corporation pursuant to its most recent S corporation election under 
section 1362.

[[Page 76613]]

    Section 1019 of TAMRA states that, except as otherwise provided, 
any amendments made by TAMRA are effective as if included in the 
provision of TRA to which such amendment relates.
    The current version of section 1374 replaced a prior version of 
section 1374 that generally only taxed income or gain recognized within 
the three year period following the date the corporation converted from 
C to S status. Section 633 of TRA, as amended by TAMRA, provides the 
effective dates of the current version of section 1374. Specifically, 
section 633(b)(1) of TRA, as amended by TAMRA, provides that the 
amendments to section 1374 apply to taxable years beginning after 
December 31, 1986, but only in cases where the return for the taxable 
year is filed pursuant to an S election made after December 31, 1986. 
Section 633(d)(8) of TRA, as amended by TAMRA, provides a transition 
rule granting a limited postponement of the above effective date for 
``qualified corporations'', which are certain small corporations as 
defined in that section. Under the transition rule, if a C corporation 
that is a qualified corporation makes an election to be an S 
corporation under section 1362 before January 1, 1989, then it is 
subject to former section 1374 for dispositions of long-term capital 
gain assets and current section 1374 for dispositions of short-term 
capital gain assets and ordinary income assets, without regard to 
whether such corporation is completely liquidated.

2. Section 1374(d)(8)

    As discussed above, the general effective date of current section 
1374, which is contained in section 633(b)(1) of the TRA, as amended by 
TAMRA, provides that current section 1374 applies to tax years 
beginning after December 31, 1986, but only in cases where the return 
for the taxable year is filed pursuant to an S election made after 
December 31, 1986. In TAMRA, Congress added subsection (d)(8) to 
section 1374, and provided that the provision was effective as if 
included in TRA.
    Section 1.1374-8 provides regulations interpreting section 
1374(d)(8). Example 1 of Sec.  1.1374-8(d) applies section 1374(d)(8) 
to a merger of a C corporation into an S corporation that elected S 
status before the effective date of TRA amendments, as further amended 
by TAMRA, to section 1374. Section 1.1374-10(a) provides that Sec.  
1.1374-8 applies for taxable years ending on or after December 27, 
1994, but only in cases where the corporation's tax return is filed 
pursuant to an S election or a section 1374(d)(8) transaction occurring 
after December 27, 1994 (emphasis added).
    Despite the provisions of Sec.  1.1374-8 and the effective date 
provisions of Sec.  1.1374-10, the IRS understands that some taxpayers 
contend that section 1374(d)(8) does not apply to carryover basis 
transfers from S corporations to S corporations that filed S elections 
before January 1, 1987, because the provisions in TAMRA that added 
section 1374(d)(8) indicated that the amendment was effective only if 
the return for the taxable year was filed pursuant to an S election 
made after December 31, 1986.
    Section 337(d)(1) authorizes the Secretary to prescribe regulations 
to prevent the circumvention of the purposes of the repeal of the 
General Utilities doctrine through the use of any provision of law or 
regulations. The Treasury Department and the IRS believe that these 
temporary regulations are necessary to implement General Utilities 
repeal to prevent the use of corporations with pre-1987 S elections as 
a method for C corporations to transfer appreciated assets out of C 
corporation solution without gain recognition. Accordingly, these 
regulations confirm that section 1374(d)(8) applies to any transaction 
described in that section that occurs on or after December 27, 1994, 
the effective date of Sec.  1.1374-8, regardless of the date of the S 
corporation's election under section 1362.

3. Revocation and Re-Election of S Corporation Status

    As discussed above, section 633(d)(8) of TRA, as amended by TAMRA, 
provides a transition rule granting a limited postponement of the 
general effective date of current section 1374 for qualified 
corporations that make an election to be an S corporation under section 
1362 before January 1, 1989. In Colorado Gas Compression, Inc. v. 
Commissioner, 366 F.3d 863 (10th Cir. 2004), reversing and remanding 
116 T.C. 1 (2001), a qualified corporation eligible for the special 
transition rule elected S corporation status on February 1, 1988 
(before the extended effective date of January 1, 1989), revoked S 
status on December 1, 1989, and subsequently re-elected S status 
effective on January 1, 1994. During the years 1994 through 1996, the 
taxpayer sold assets. The Tax Court held that such sales were subject 
to current section 1374, and that the transition rule did not preclude 
the application of current section 1374 because the taxpayer's most 
recent S election was made after 1989. The Tax Court concluded that 
section 1374(d)(9) requires that the 1994 election, the taxpayer's most 
recent election, be the election considered for effective date 
purposes. The Tenth Circuit reversed the Tax Court, holding that, 
because the 1988 election was made before the extended effective date, 
the corporation was exempt from current section 1374 despite the 
intervening revocation of S status.
    The Treasury Department and the IRS believe that the Tenth 
Circuit's holding is inconsistent with the legislative history and 
underlying policy of section 663 of TRA, as amended by TAMRA, and 
believe the Tax Court was correct in holding that a corporation's most 
recent S election must have been made before the deadline of the 
transition rule (i.e., before January 1, 1989) in order for the 
corporation to be entitled to the benefit of the transition rule. As 
indicated above, section 337(d)(1) authorizes the Secretary to 
prescribe regulations to prevent the circumvention of the purposes of 
the repeal of the General Utilities doctrine through the use of any 
provision of law or regulations. The Treasury Department and the IRS 
believe that these temporary regulations are necessary to implement 
General Utilities repeal to prevent avoidance of corporate level tax on 
appreciation in the assets of a C corporation attributable to periods 
after the extended effective date of January 1, 1989. Accordingly, 
these regulations provide that the transition rule regarding qualified 
corporations in section 633(d)(8) of TRA, as amended by TAMRA, applies 
only if the corporation's most recent S election was made before 
January 1, 1989. Although these regulations apply to built-in gain 
recognized in taxable years beginning after December 22, 2004, the IRS 
will continue to assert this position for prior taxable years.
    In summary, the temporary regulations provide that (1) section 
1374(d)(8) applies to any transaction described in that section that 
occurs on or after December 27, 1994, regardless of the date of the S 
corporation's election under section 1362, and (2) for purposes of 
section 633(d)(8) of TRA, as amended by TAMRA, a corporation's most 
recent S election, not an earlier election that has been revoked or 
terminated, determines whether or not it is subject to current section 
1374.

Special Analyses

    It has been determined that this temporary regulation is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It

[[Page 76614]]

also has been determined that section 553(b) of the Administrative 
Procedure Act (5 U.S.C. chapter 5) does not apply to Sec.  1.1374-
8T(a)(2) of these regulations. With respect to Sec.  1.1374-10T(c) of 
these regulations, it has been determined, pursuant to 5 U.S.C. 
553(b)(B), that it would be contrary to the public interest to issue 
the regulations with notice and public procedure and, pursuant to 5 
U.S.C. 553(d)(3), that good cause exists to dispense with a delayed 
effective date. The regulations are necessary to provide immediate 
guidance to taxpayers with respect to the application of the transition 
rule regarding qualified corporations in section 633(d)(8) of TRA, as 
amended by TAMRA, and, accordingly, with respect to the application of 
current section 1374 to asset dispositions which occur during taxable 
years beginning after December 22, 2004. For applicability of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special 
Analysis section of the Notice of Proposed Rulemaking published in the 
Proposed Rules section in this issue of the Federal Register. Pursuant 
to section 7805(f) of the Code, these temporary regulations have been 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Stephen R. Cleary of 
the Office of Associate Chief Counsel (Corporate). Other personnel from 
Treasury and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of 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 adding 
entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1374-8T also issued under 26 U.S.C. 337(d) and 
1374(e). * * *
    Section 1.1374-10T also issued under 26 U.S.C. 337(d) and 
1374(e). * * *

0
Par. 2. Section 1.1374-8 is amended by redesignating paragraph (a) as 
paragraph (a)(1) and adding paragraph (a)(2) to read as follows:


Sec.  1.1374-8  Section 1374(d)(8) transactions

    (a)(1) * * *
    (2) (Reserved) For further guidance see Sec.  1.1374-8T(a)(2).
* * * * *

0
Par. 3. Section 1.1374-8T is added to read as follows:


Sec.  1374-8T  1374(d)(8) transactions (temporary)

    (a)(1) (Reserved) For further guidance see Sec.  1374-8(a).
    (2) Section 1374(d)(8) transaction, as defined in paragraph (a)(1) 
of this regulation, that occurs on or after December 27, 1994, without 
regard to the date of the corporation's election to be an S corporation 
under section 1362.
    (b) through (d) (Reserved) For further guidance see Sec.  1.1374-
8(b) through (d).

0
Par. 4. Section 1.1374-10 is amended by adding paragraph (c) to read as 
follows:


Sec.  1.1374-10  Effective date and additional rules

* * * * *
    (c) (Reserved) For further guidance see Sec.  1.1374-10T(c).

0
Par. 5. Section 1.1374-10T is added to read as follows:


Sec.  1.1374-10T  Effective date and additional rules (temporary)

    (a) through (b)(4) (Reserved) For further guidance see Sec.  
1.1374-10(a) through (b)(4).
    (c) Revocation and re-election of S corporation status--(1) In 
general. For purposes of section 633(d)(8) of the Tax Reform Act of 
1986, as amended, any reference to an election to be an S corporation 
under section 1362 shall be treated as a reference to the corporation's 
most recent election to be an S corporation under section 1362. This 
paragraph (c) applies for taxable years beginning after December 22, 
2004 without regard to the date of the corporation's most recent 
election to be an S corporation under section 1362.
    (2) Example. The following example illustrates the rules of this 
paragraph(c):
    Example. (i) On February 1, 1988, X, a C corporation that is a 
qualified corporation under section 633(d) of the Tax Reform Act of 
1986, as amended, elects to be an S corporation under section 1362. 
On December 1, 1989, X revokes its S status and becomes a C 
corporation. On January 1, 2004, X again elects to be an S 
corporation under section 1362. X disposes of assets in 2006, 2007, 
and 2008, recognizing gain.
    (ii) X is not eligible for treatment under the Transition rule 
of section 633(d)(8) of the Tax Reform Act of 1986, as amended, with 
respect to these assets. Accordingly, X is subject to section 1374, 
as amended by the Tax Reform Act of 1986 and TAMRA, and the 10-year 
recognition period begins January 1, 2004.
    (iii) To the extent the gain that X recognizes on the assest 
sales in 2006, 2007, and 2008 reflects built-in gain inherent in 
such assets in X's hands on January 1, 2004, such gain is subject to 
tax under section 1374 as amended by the Tax Reform Act of 1986 and 
TAMRA.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.

    Approved: December 15, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-28013 Filed 12-21-04; 8:45 am]
BILLING CODE 4820-01-M