[Federal Register Volume 72, Number 114 (Thursday, June 14, 2007)]
[Rules and Regulations]
[Pages 32792-32794]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-11438]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9330]
RIN 1545-BG66


Built-in Gains and Losses Under Section 382(h)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations that apply to 
corporations that have undergone ownership changes within the meaning 
of section 382. These regulations provide guidance regarding the 
treatment of prepaid income under the built-in gain provisions of 
section 382(h). The text of these 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 on June 14, 
2007.
    Applicability Date: For dates of applicability, see Sec.  1.382-
7T(b).

FOR FURTHER INFORMATION CONTACT: Keith Stanley at (202) 622-7750 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Section 382

    Section 382 limits, after a more than 50 percent change in stock 
ownership (ownership change), the amount of a loss corporation's 
taxable income for any post-change year that may be offset by pre-
change losses. The amount of the limitation each year is equal to the 
product of the fair market value of all the stock of the loss 
corporation immediately before the ownership change multiplied by the 
applicable long-term tax-exempt rate (section 382 limitation).
    Section 382(h)(1)(A) provides that if the loss corporation has a 
net unrealized built-in gain (NUBIG), the section 382 limitation for 
any taxable year ending within a 5-year recognition period is increased 
by the recognized built-in gain (RBIG) for the taxable year, subject to 
the NUBIG limitation. Section 382(h)(2)(A) defines RBIG as any gain 
recognized during the 5-year recognition period on the disposition of 
any asset to the extent the loss corporation establishes that (i) It 
held the asset on the change date and (ii) such gain does not exceed 
the asset's built-in gain on the change date. Section 382(h)(6)(A) also 
treats as RBIG any item of income ``properly taken into account during 
the recognition period'' if the item is ``attributable to periods 
before the change date.''
    In Notice 2003-65 (2003-2 CB 747), the IRS provided interim 
guidance regarding the identification of built-in gains and losses 
under section 382(h). The Notice provides, among other things, that a 
loss corporation may use the 338 approach in determining the amount of 
its RBIG or recognized built-in loss (RBIL) for purposes of section 
382(h). The 338 approach identifies items of RBIG and RBIL generally by 
comparing the loss corporation's actual items of income, gain, 
deduction, and loss with those that would have resulted if a section 
338 election had been made with respect to a hypothetical purchase of 
all of the outstanding stock of the loss corporation on the change 
date.

Prepaid Income

    Generally, a taxpayer, including an accrual method taxpayer that 
receives payments in advance of performance, must include the payments 
in gross income in the taxable year of receipt without regard to 
whether the required performance has occurred. In Schlude v. 
Commissioner, 372 U.S. 128 (1963), the Supreme Court held that advance 
payments for dance lessons were includable in gross income when 
received because the payments were nonrefundable and the services were 
provided on demand of the student. In American Automobile Association 
v. United States, 367 U.S. 687 (1961), the Supreme Court held that 
membership dues entitling members to emergency road assistance and 
trip-planning services were includable in gross income when received, 
even though the taxpayer's method reflected income in accordance with 
generally accepted accounting principles (which generally operate to 
defer income recognition until the item is economically earned).
    However, courts have allowed the deferral of prepaid income in 
limited circumstances. In Artnell Co. v.

[[Page 32793]]

Commissioner, 400 F. 2d 981 (7th Cir. 1968), the court held that 
amounts received on advance ticket sales relating to major league 
baseball games to be played on fixed dates in the next year could be 
deferred to that year. In Tampa Bay Devil Rays, Ltd. v. Commissioner, 
T.C. Memo 2002-248, the Tax Court held that deposits received by a new 
baseball franchise (Devil Rays) in 1995 and 1996 on advance season 
tickets for major league baseball games to be played by the Devil Rays 
in its first season in 1998 could be deferred until 1998, even though 
the deferral period was greater than a year. The Tax Court emphasized 
that the games were to be played on a fixed and definite schedule in 
1998 and that deferral more clearly matched the deposits with the 
related expenses that were incurred and deducted in 1998.
    Congress, the IRS, and Treasury Department have allowed deferral of 
prepaid income in certain circumstances. For example, section 455 
allows taxpayers that have prepaid subscription income for newspapers, 
magazines, and other periodicals to elect to defer such income to the 
taxable years during which the liability to furnish or deliver the 
newspaper, magazine, or periodical exists. Section 1.451-5(b)(1)(ii) 
allows advance payments for the sale of goods to be deferred to the 
year the payments are included in gross receipts under the taxpayer's 
method of accounting for tax purposes (such as when the goods are 
shipped or delivered), unless the income is recorded earlier for 
purposes of the taxpayer's financial statements. For goods that must be 
inventoried the permitted deferral is further limited by Sec.  1.451-
5(c)(1) to the second year following the year substantial advance 
payments, as defined in Sec.  1.451-5(c)(3), are received.
    Revenue Procedure 71-21 (1971-2 CB 549), which was modified and 
superseded by Rev. Proc. 2004-34 (2004-1 CB 991), allowed accrual 
method taxpayers that received a payment in one taxable year for 
services to be performed before the end of the next succeeding taxable 
year to defer income inclusion until the services were performed (but 
no later than the end of the succeeding taxable year). The stated 
purpose of the Revenue Procedure was to reconcile the tax accounting 
treatment of such payments with the financial accounting conventions 
consistently used by accrual method taxpayers in the treatment of such 
payments. Rev. Proc. 2004-34 allows a qualifying taxpayer to defer 
advance payments for services (and for certain non-services and 
combinations of services and non-services) to the taxable year 
succeeding the taxable year of receipt to the extent the taxpayer 
establishes that the advance payments are not recognized in revenues in 
the taxpayer's applicable financial statement in the taxable year of 
receipt; or, if the taxpayer does not have an applicable financial 
statement, the payment is not earned in the taxable year of receipt.
    The common purpose of the prepaid income deferral provisions 
described above is to better match the taxpayer's income with the 
expenses incurred to earn that income and, as a result, to more clearly 
reflect the taxpayer's income both in the year of receipt and in the 
year of performance.
    Certain taxpayers are taking the position that prepaid income 
received in the period before the change date (pre-change period) but 
included in gross income in the recognition period is RBIG. As further 
explained below, the IRS and Treasury Department believe that prepaid 
income is attributable to the period on or after the change date (post-
change period) rather than the pre-change period. Thus, treating 
prepaid income as RBIG is inconsistent with the purposes of section 
382(h).

Explanation of Provisions

    This temporary regulation provides that prepaid income is not 
recognized built-in gain. The term prepaid income means any amount 
received prior to the change date that is attributable to performance 
occurring on or after the change date. Examples to which the temporary 
regulation applies include, but are not limited to, income received 
prior to the change date that is deferred under section 455, Sec.  
1.451-5, or Rev. Proc. 2004-34 (or any successor revenue procedure).
    The IRS and Treasury Department believe that the section 382 
legislative history, through the examples set forth therein, supports 
the position that prepaid income should not be treated as RBIG for 
section 382 purposes. The House and Senate Committee Reports that 
accompanied the enactment of section 382(h)(6)(A) both state that items 
of income attributable to the pre-change period include accounts 
receivable of a cash basis taxpayer that arose before the change date 
and are collected after that date, the gain on completion of a long-
term contract performed by a taxpayer using the completed contract 
method of accounting that is attributable to the pre-change period, and 
the recognition of income attributable to the pre-change period 
pursuant to section 481 adjustments, as when the loss corporation is 
required to change to the accrual method. See H. Rep. No. 100-795, 46 
(1988); S. Rep. No. 100-445, 48 (1988).
    The IRS and Treasury Department believe that prepaid income is 
distinguishable from the income items described in the committee report 
examples. In each of the committee report examples, the item of income 
is attributable to the pre-change period because that is the period in 
which performance occurred and expenses were incurred to earn the 
income. By contrast, prepaid income is attributable to the post-change 
period because that is the period in which performance occurred and 
expenses were incurred to earn the income. Therefore, because prepaid 
income is attributable to the post-change period rather than the pre-
change period, the IRS and Treasury Department have determined that 
such prepaid income should not be treated as RBIG under section 382(h).
    The 338 approach described in Notice 2003-65 hereinafter will be 
applied consistently with this temporary regulation.

Comments

    The text of these 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. Please see the ``Comments and Requests for a Public 
Hearing'' section of the notice of proposed rulemaking for the 
procedures to follow in submitting comments on the proposed regulations 
on this subject.
    In preparing comments on the proposed regulations, please consider 
the following. In Notice 2003-65, comments were requested regarding the 
different approaches, including the 338 approach, set forth for 
determining RBIG and RBIL under section 382(h). The IRS and Treasury 
Department believe the 338 approach, in most cases, will properly 
identify whether or not an item of income or deduction is treated as 
RBIG or RBIL. However, the IRS and Treasury Department are concerned 
that taking items of income and deduction into account separately may 
cause the 338 approach, in some cases, to not properly identify whether 
or not an item of income or deduction is treated as RBIG or RBIL. The 
purpose of section 382(h)(6) is to treat items of income or deduction 
in similar fashion to gain and loss under section 382(h)(2). However, 
under general tax principles, there is a fundamental difference between 
the treatment of items of income or deduction and items of gain or 
loss. On the one hand, under section 382(h)(2),

[[Page 32794]]

which incorporates the principles of section 1001, gain or loss on the 
disposition of an asset is taken into account net of the taxpayer's 
basis, or investment, in the assets. In contrast, under section 
382(h)(6), an item of income is generally a gross amount that is not 
netted and therefore not necessarily matched with the item of deduction 
incurred to earn the item of income.
    Therefore, the IRS and Treasury Department request comments on the 
proposed regulations about identifying cases where taking into account 
items of income and deduction separately may cause the 338 approach to 
not properly identify whether or not an item of income or deduction is 
treated as RBIG or RBIL, and how the 338 approach might be adapted so 
that in such cases it properly identifies whether or not an item of 
income or deduction is treated as RBIG or RBIL.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12666. 
Therefore, a regulatory assessment is not required. These temporary 
regulations address situations in which taxpayers inappropriately 
attempt to treat deferred prepaid income as net unrealized built-in 
gain for purposes of increasing the amount of post-ownership change 
income that may be offset by pre-ownership change losses. For this 
reason, it has been determined pursuant to 5 U.S.C. 553(b)(B) that 
prior notice and public procedure are impracticable and contrary to the 
public interest. For the same reason, it has been determined pursuant 
to 5 U.S.C. 553(d)(3) that good cause exists to make these temporary 
regulations effective upon the date of publication. For 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 the 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 will be 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 Sean McKeever, Office 
of Associate Chief Counsel (Corporate). However, other personnel from 
the IRS and Treasury Department participated in their development.

Availability of IRS Documents

    IRS revenue rulings, procedures, and notices cited in this preamble 
are made available by the Superintendent of Documents, U.S. Government 
Printing Office, Washington, DC 20402.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

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

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805. * * *
    Section 1.382-7T also issued under 26 U.S.C. 382(m).* * *

0
Par. 2. Section 1.382-7T is added to read as follows:


Sec.  1.382-7T  Built-in gains and losses (temporary).

    (a) Treatment of prepaid income. For purposes of section 382(h), 
prepaid income is not recognized built-in gain. The term prepaid income 
means any amount received prior to the change date that is attributable 
to performance occurring on or after the change date. Examples to which 
this paragraph (a) will apply include, but are not limited to, income 
received prior to the change date that is deferred under section 455, 
Sec.  1.451-5, or Rev. Proc. 2004-34 (2004-1 CB 991) (or any successor 
revenue procedure) (see Sec.  601.601(d)(2) of this chapter).
    (b) Effective/applicability date. (1) This section applies to loss 
corporations that have undergone an ownership change on or after June 
14, 2007.
    (2) The applicability of this section expires on or before June 14, 
2010.

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
Eric Solomon,
Assistant Secretary of the Treasury.
[FR Doc. E7-11438 Filed 6-13-07; 8:45 am]
BILLING CODE 4830-01-P