[Federal Register Volume 74, Number 209 (Friday, October 30, 2009)]
[Rules and Regulations]
[Pages 56109-56113]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-26152]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9469]
RIN 1545-BH54


Section 108 Reduction of Tax Attributes for S Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that provide guidance 
on the manner in which an S corporation reduces its tax attributes 
under section 108(b) for taxable years in which the S corporation has 
discharge of indebtedness income that is excluded from gross income 
under section 108(a). In particular, the regulations address situations 
in which the aggregate amount of the shareholders' disallowed section 
1366(d) losses and deductions that are treated as a net operating loss 
tax attribute of the S corporation exceeds the amount of the S 
corporation's excluded discharge of indebtedness income. The 
regulations affect S corporations and their shareholders.

DATES: Effective Date: These regulations are effective on October 30, 
2009.
    Applicability Date: For dates of applicability, see Sec.  1.108-
7(f)(2).

FOR FURTHER INFORMATION CONTACT: Jennifer N. Keeney, (202) 622-3060 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collections of information contained in these final regulations 
were previously reviewed and approved by the Office of Management and 
Budget in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)) under control number 1545-2155. The collections of 
information in this final regulation are in Sec.  1.108-7(d)(4). This 
information must be provided by S corporations that exclude discharge 
of indebtedness income from gross income under section 108(a) and 
shareholders of those S corporations. The information provided by 
shareholders will be used by S corporations to properly reduce their 
tax attributes under section 108(b). The information provided by S 
corporations will be used by shareholders of those S corporations to 
calculate their taxable income in succeeding taxable years.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR Part 1) under section 108 of the Internal Revenue Code (Code).
    Section 61(a) provides that gross income means all income from 
whatever source derived, including (but not limited to) income from 
discharge of indebtedness, also known as cancellation of debt income 
(COD income). Section 108(a) provides an exclusion from gross income 
for COD income if the discharge occurs while the taxpayer is bankrupt 
or insolvent, or if the indebtedness discharged is qualified farm 
indebtedness, certain qualified real property business indebtedness, or 
certain qualified principal residence indebtedness. In the case of a 
discharge of indebtedness during insolvency, the exclusion from income 
is limited to the amount by which the taxpayer is insolvent. Section 
108(b) provides that the taxpayer must reduce certain specified tax 
attributes to the extent COD income is excluded from gross income under 
section 108(a)(1)(A), (B), or (C). Section 108(b) also provides the 
order in which these tax attributes must be reduced. Unless the 
taxpayer makes an election under section 108(b)(5) to first reduce the 
basis of depreciable property, section 108(b)(2)(A) provides that the 
first tax attribute to be reduced is any net operating loss for the 
taxable year of the discharge, and any net operating loss carryover to 
such taxable year.
    A notice of proposed rulemaking and a notice of public hearing 
(REG-102822-08, 2008-38 IRB 744) were published in the Federal Register 
(73 FR 45656) on August 6, 2008, proposing amendments to the 
regulations regarding the manner in which an S corporation reduces its 
tax attributes under section 108(b) for taxable years in which the S 
corporation has discharge of indebtedness income that is excluded from 
gross income under section 108(a). A public hearing on the proposed 
regulations was scheduled for December 8, 2008 but was cancelled 
because no one requested to speak. However, comments responding to the 
proposed regulations were received. After consideration of these 
comments, the proposed regulations are adopted as revised by this 
Treasury decision. These final regulations generally retain the 
provisions of the proposed regulations, with the modifications 
discussed in this preamble.

Summary of Comments and Explanation of Revisions

A. Allocation of Excess Losses and Deductions After Section 108(b) Tax 
Attribute Reduction

    Section 108 provides special rules for an S corporation that has 
COD income. Section 108(d)(7)(A), as amended by the Job Creation and 
Worker Assistance Act of 2002, Public Law 107-147, provides, in part, 
that the rules under section 108(a) for the exclusion of COD income and 
under section 108(b) for the reduction of tax attributes are applied at 
the corporate level, including by not

[[Page 56110]]

taking into account under section 1366(a) any amount excluded under 
section 108(a). Therefore, if an S corporation excludes COD income from 
its gross income under section 108(a), the amount excluded is applied 
to reduce the S corporation's tax attributes under section 108(b)(2). 
Under section 108(b)(4)(A), the reduction of tax attributes occurs 
after the S corporation's items of income, loss, deduction and credit 
for the taxable year of the discharge pass through to its shareholders 
under section 1366(a). Under section 1366(d)(1), the aggregate amount 
of losses and deductions a shareholder can take into account under 
section 1366(a) cannot exceed the shareholder's adjusted basis in the 
shareholder's stock in the S corporation and the shareholder's adjusted 
basis of any indebtedness of the S corporation to the shareholder. For 
purposes of the tax attribute reduction rule under section 108(b)(2), 
section 108(d)(7)(B) provides that any loss or deduction that is 
disallowed for the taxable year of the discharge under section 
1366(d)(1) is treated as a net operating loss of the S corporation 
(deemed NOL).
    Several commentators recommended that net operating losses of an S 
corporation carried forward from one or more C corporation taxable 
years (C Year NOLs) should be considered S corporation tax attributes 
for purposes of section 108(b)(2). The proposed regulations are silent 
on whether attributes such as net operating losses, capital losses, and 
business credits arising in a C corporation taxable year should be 
considered tax attributes of the S corporation for purposes of section 
108(b)(2). Section 1371(b)(1) states that no carryforward, and no 
carryback, arising for a taxable year for which a corporation is a C 
corporation may be carried to a taxable year for which such corporation 
is an S corporation. This prohibition applies to tax attribute 
carryovers described in section 108(b)(2). For example, section 
108(b)(2)(A) describes a net operating loss tax attribute as ``any net 
operating loss for the taxable year of discharge and any net operating 
loss carryover to such taxable year.'' Accordingly, section 1371(b)(1) 
prohibits an S corporation from using a C Year NOL as an S corporation 
tax attribute for purposes of section 108(b)(2). The same analysis 
applies to capital losses and business credits that arose in a C 
corporation taxable year. Therefore, the final regulations do not adopt 
this recommendation.
    One commentator suggested that the final regulations clarify how 
the allocation rules in Sec.  1.108-7(d)(2) of the proposed regulations 
apply when an S corporation, with the consent of all affected 
shareholders, makes an election under section 1377(a)(2) (a terminating 
election). Regardless of whether a terminating election is made, all 
disallowed losses and deductions of a shareholder under section 
1366(d)(1), including disallowed losses and deductions of a terminating 
shareholder, are treated as an S corporation's deemed NOL. The impact 
of a terminating election on the allocation of the COD income, however, 
may result in a different allocation of the S corporation's excess 
deemed NOL among the shareholders. Therefore, the final regulations add 
an example to clarify how the allocation rules apply when a terminating 
election is made.
    Commentators asked whether a deemed NOL described in section 
108(d)(7)(B) includes any losses that are suspended under section 465 
or section 469. Section 108(d)(7)(B) provides that a deemed NOL is any 
loss or deduction which is disallowed for the taxable year of the 
discharge under section 1366(d)(1). Section 1366(d)(1) specifically 
provides for the disallowance of losses due only to lack of basis. 
Therefore, a deemed NOL does not include losses suspended under section 
465 or section 469.
    One commentator requested that the final regulations clarify 
whether disallowed losses and deductions under section 1366(d)(1) of a 
shareholder that is an employee stock ownership plan (ESOP) are 
included in the S corporation's deemed NOL. Section 108(d)(7)(B) 
provides that any loss or deduction that is disallowed for the taxable 
year of the discharge under section 1366(d)(1) is treated as a deemed 
NOL of the S corporation. Accordingly, section 108(d)(7)(B) applies to 
any shareholder, including an ESOP shareholder, that has disallowed 
losses and deductions for the taxable year of the discharge under 
section 1366(d)(1).
    One commentator asked whether nondeductible, noncapital expenses 
that reduce basis under section 1367(a)(2)(D) are treated as disallowed 
losses and deductions under section 1366(d)(1) for purposes of section 
108(d)(7)(B). These expenses, including any that are carried over as a 
result of the elective ordering rule in Sec.  1.1367-1(g) of the Income 
Tax Regulations, are not losses and deductions that can be taken into 
account by a shareholder under section 1366(a) and therefore are not 
included as disallowed losses and deductions under section 1366(d)(1) 
for purposes of section 108(d)(7)(B).
    One commentator noted that in some situations, an S corporation 
shareholder may have a different taxable year than the S corporation. 
The commentator asked whether, in these situations, a shareholder 
determines its disallowed losses and deductions under section 
1366(d)(1) for purposes of section 108(d)(7) as of the close of the S 
corporation's taxable year. The basis adjustments under section 1367 
are determined as of the close of the S corporation's taxable year. See 
Sec.  1.1367-1(d)(1) and Sec.  1.1367-2(d)(1). Therefore, a 
shareholder's disallowed losses and deductions under section 1366(d)(1) 
are determined for purposes of section 108(d)(7) as of the close of the 
S corporation's taxable year.
    Finally, one commentator recommended that the final regulations 
provide that all shareholders share tax attribute reductions in 
proportion to their ownership interests in the S corporation in all 
situations. The preamble to the proposed regulations noted that 
shareholders may be disproportionately impacted where the shareholders' 
respective disallowed losses or deductions are disproportionate to 
their respective interests. However, the disproportionate impact that 
occurs in certain situations is a result of the statutory provisions of 
section 108. Therefore, the final regulations do not adopt this 
recommendation. In certain situations, an S corporation may eliminate 
or mitigate inequitable results by making an election under section 
108(b)(5) to reduce the basis of its depreciable property before 
reducing its net operating loss.

B. Character of Excess Deemed NOL Allocated to a Shareholder

    The proposed regulations provide an ordering approach for 
determining the character of the amount of the S corporation's excess 
deemed NOL that is allocated to a shareholder. The approach in the 
proposed regulations is generally consistent with the ordering rules of 
section 108(b)(2) in that ordinary losses are reduced before capital 
losses. One commentator recommended that the final regulations adopt an 
approach that is consistent with the method for determining the 
character of a shareholder's losses and deductions under section 
1366(d). Under this approach, the S corporation's excess deemed NOL 
that is allocated to a shareholder consists of a proportionate amount 
of each item of the shareholder's loss or deduction that is disallowed 
for the taxable year of the discharge under section 1366(d)(1). After 
considering this comment, the IRS and Treasury have decided to adopt 
this approach in the final regulations.

[[Page 56111]]

C. Information Sharing Requirements

    The proposed regulations require a shareholder of an S corporation 
that excludes COD income from its gross income in a taxable year to 
report to the S corporation the amount of the shareholder's losses and 
deductions that are disallowed for the taxable year of the discharge 
under section 1366(d)(1) (shareholder-information reporting 
requirement). The proposed regulations also require the S corporation 
to report to its shareholders the amount of any excess deemed NOL that 
is allocated to a shareholder (S corporation-information reporting 
requirement). Commentators recommended changes to the shareholder-
information reporting requirement to minimize dependence on information 
furnished by shareholders who provide (intentionally or 
unintentionally) incorrect information or on shareholders who fail to 
furnish this information. One commentator explained that as a practical 
matter, an S corporation often maintains records for its shareholders 
and may possess all the requisite information to determine the amount 
of a shareholder's suspended loss under section 1366(d). Another 
commentator requested that the final regulations provide consequences 
for shareholders who do not comply with the shareholder-information 
reporting requirement or who provide incorrect information.
    After considering these comments, the final regulations modify the 
shareholder-information reporting requirement to alleviate the 
dependence on shareholders who fail to furnish information or who 
provide incorrect information. The final regulations provide that in 
certain situations, the S corporation may rely on its own books and 
records as well as other information available to the S corporation to 
determine a shareholder's disallowed losses or deductions under section 
1366(d)(1), provided that the S corporation knows that the amount 
reported by the shareholder is inaccurate, or the information, as 
provided, appears to be incomplete or incorrect. The final regulations 
do not adopt any special rules to provide for consequences to 
shareholders who either fail to report this information to the S 
corporation or report incorrect information to the S corporation. 
However, the IRS and Treasury note that section 6037(c) requires that a 
shareholder of an S corporation, on the shareholder's return, treat a 
``subchapter S item'' in a manner consistent with the S corporation 
return. The IRS and Treasury believe that the S corporation's excess 
deemed NOL that is allocated to a shareholder is a ``subchapter S 
item'' for purposes of section 6037(c) and that the consequences of 
failure to comply with section 6037(c) are sufficient to encourage 
shareholders to cooperate with the S corporation in order to avoid 
inconsistencies between the S corporation's return and the 
shareholder's return.

Effective/Applicability Date

    The final regulations apply to discharges of indebtedness occurring 
on or after October 30, 2009.

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. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. It is hereby 
certified that the collection of information contained in these 
regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that the collection burden imposed on S corporations and their 
shareholders is minimal in that it requires S corporations and their 
shareholder(s) to share information that shareholders already maintain 
to determine their respective tax liabilities. Moreover, it should take 
an S corporation or a shareholder no more than one hour to satisfy the 
information sharing requirements in these regulations. Finally, the 
collection burden imposed applies only to S corporations that are 
required to reduce their tax attributes under section 108(b) of the 
Code--a group estimated to be less than 1 percent of all existing S 
corporations. Therefore, 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 Code, the notice of proposed 
rulemaking that preceded these regulations was 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 these regulations is Jennifer N. Keeney, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the IRS and Treasury 
participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 and part 602 are 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 1.108-7 is amended by:
0
1. Redesignating paragraphs (d) and (e) as paragraphs (e) and (f), 
respectively.
0
2. Adding new paragraph (d).
0
3. Adding paragraph (e) Example 5, Example 6, and Example 7 to newly-
redesignated paragraph (e).
0
4. Revising newly-redesignated paragraph (f).
    The additions and revision read as follows:


Sec.  1.108-7  Reduction of attributes.

* * * * *
    (d) Special rules for S corporations--(1) In general. If an S 
corporation excludes COD income from gross income under section 
108(a)(1)(A), (B), or (C), the amount excluded shall be applied to 
reduce the S corporation's tax attributes under paragraph (a)(1) of 
this section. For purposes of paragraph (a)(1)(i) of this section, the 
aggregate amount of the shareholders' losses or deductions that are 
disallowed for the taxable year of the discharge under section 
1366(d)(1), including disallowed losses or deductions of a shareholder 
that transfers all of the shareholder's stock in the S corporation 
during the taxable year of the discharge, is treated as the net 
operating loss tax attribute (deemed NOL) of the S corporation for the 
taxable year of the discharge.
    (2) Allocation of excess losses or deductions--(i) In general. If 
the amount of an S corporation's deemed NOL exceeds the amount of the S 
corporation's COD income that is excluded from gross income under 
section 108(a)(1)(A), (B), or (C), the excess deemed NOL shall be 
allocated to the shareholder or shareholders of the S corporation as a 
loss or deduction that is disallowed under section 1366(d) for the 
taxable year of the discharge.

[[Page 56112]]

    (ii) Multiple shareholders--(A) In general. If an S corporation has 
multiple shareholders, to determine the amount of the S corporation's 
excess deemed NOL to be allocated to each shareholder under paragraph 
(d)(2)(i) of this section, calculate with respect to each shareholder 
the shareholder's excess amount. The shareholder's excess amount is the 
amount (if any) by which the shareholder's losses or deductions 
disallowed under section 1366(d)(1) (before any reduction under 
paragraph (a)(1) of this section) exceed the amount of COD income that 
would have been taken into account by that shareholder under section 
1366(a) had the COD income not been excluded under section 108(a).
    (B) Shareholders with a shareholder's excess amount. Each 
shareholder that has a shareholder's excess amount, as determined under 
paragraph (d)(2)(ii)(A) of this section, is allocated an amount equal 
to the S corporation's excess deemed NOL multiplied by a fraction, the 
numerator of which is the shareholder's excess amount and the 
denominator of which is the sum of all shareholders' excess amounts.
    (C) Shareholders with no shareholder's excess amount. If a 
shareholder does not have a shareholder's excess amount as determined 
in paragraph (d)(2)(ii)(A) of this section, none of the S corporation's 
excess deemed NOL shall be allocated to that shareholder.
    (iii) Terminating shareholder. Any amount of the S corporation's 
excess deemed NOL allocated under paragraph (d)(2) of this section to a 
shareholder that had transferred all of the shareholder's stock in the 
corporation during the taxable year of the discharge is permanently 
disallowed under Sec.  1.1366-2(a)(5), unless the transfer of stock is 
described in section 1041(a). If the transfer of stock is described in 
section 1041(a), the amount of the S corporation's excess deemed NOL 
allocated to the transferor under paragraph (d)(2) of this section 
shall be treated as a loss or deduction incurred by the corporation in 
the succeeding taxable year with respect to the transferee. See section 
1366(d)(2)(B).
    (3) Character of excess losses or deductions allocated to a 
shareholder. The character of an S corporation's excess deemed NOL that 
is allocated to a shareholder under paragraph (d)(2) of this section 
consists of a proportionate amount of each item of the shareholder's 
loss or deduction that is disallowed for the taxable year of the 
discharge under section 1366(d)(1).
    (4) Information requirements. If an S corporation excludes COD 
income from gross income under section 108(a) for a taxable year, each 
shareholder of the S corporation during the taxable year of the 
discharge must report to the S corporation the amount of the 
shareholder's losses and deductions that are disallowed for the taxable 
year of the discharge under section 1366(d)(1), even if that amount is 
zero. If a shareholder fails to report the amount of the shareholder's 
losses and deductions that are disallowed for the taxable year of the 
discharge under section 1366(d)(1) to the S corporation, or if the S 
corporation knows that the amount reported by the shareholder is 
inaccurate, or if the information, as reported, appears to be 
incomplete or incorrect, the S corporation may rely on its own books 
and records, as well as other information available to the S 
corporation, to determine the amount of the shareholder's losses and 
deductions that are disallowed for the taxable year of the discharge 
under section 1366(d)(1), provided that the S corporation knows or 
reasonably believes that its information presents an accurate 
reflection of the shareholder's disallowed losses and deductions under 
section 1366(d)(1). The S corporation must report to each shareholder 
the amount of the S corporation's excess deemed NOL that is allocated 
to that shareholder under paragraph (d)(2) of this section, even if 
that amount is zero, in accordance with applicable forms and 
instructions.
    (e) * * *

    Example 5. (i) Facts. During the entire calendar year 2009, A, 
B, and C each own equal shares of stock in X, a calendar year S 
corporation. As of December 31, 2009, A, B, and C each have a zero 
stock basis and X does not have any indebtedness to A, B, or C. For 
the 2009 taxable year, X excludes from gross income $45,000 of COD 
income under section 108(a)(1)(A). The COD income (had it not been 
excluded) would have been allocated $15,000 to A, $15,000 to B, and 
$15,000 to C under section 1366(a). For the 2009 taxable year, X has 
$30,000 of losses and deductions that X passes through pro rata to 
A, B, and C in the amount of $10,000 each. The losses and deductions 
that pass through to A, B, and C are disallowed under section 
1366(d)(1). In addition, B has $10,000 of section 1366(d) losses 
from prior years and C has $20,000 of section 1366(d) losses from 
prior years. A's ($10,000), B's ($20,000) and C's ($30,000) combined 
$60,000 of disallowed losses and deductions for the taxable year of 
the discharge are treated as a current year net operating loss tax 
attribute of X under section 108(d)(7)(B) (deemed NOL) for purposes 
of the section 108(b) reduction of tax attributes.
    (ii) Allocation. Under section 108(b)(2)(A), X's $45,000 of 
excluded COD income reduces the $60,000 deemed NOL to $15,000. 
Therefore, X has a $15,000 excess net operating loss (excess deemed 
NOL) to allocate to its shareholders. Under paragraph (d)(2)(ii)(C) 
of this section, none of the $15,000 excess deemed NOL is allocated 
to A because A's section 1366(d) losses and deductions immediately 
prior to the section 108(b)(2)(A) reduction ($10,000) do not exceed 
A's share of the excluded COD income for 2008 ($15,000). Thus, A has 
no shareholder's excess amount. Each of B's and C's respective 
section 1366(d) losses and deductions immediately prior to the 
section 108(b)(2)(A) reduction exceed each of B's and C's respective 
shares of the excluded COD income for 2008. B's excess amount is 
$5,000 ($20,000-$15,000) and C's excess amount is $15,000 ($30,000-
$15,000). Therefore, the total of all shareholders' excess amounts 
is $20,000. Under paragraph (d)(2) of this section, X will allocate 
$3,750 of the $15,000 excess deemed NOL to B ($15,000 x $5,000/
$20,000) and $11,250 of the $15,000 excess deemed NOL to C ($15,000 
x $15,000/$20,000). These amounts are treated as losses and 
deductions disallowed under section 1366(d)(1) for the taxable year 
of the discharge. Accordingly, at the beginning of 2010, A has no 
section 1366(d)(2) carryovers, B has $3,750 of carryovers, and C has 
$11,250 of carryovers.
    (iii) Character. Immediately prior to the section 108(b)(2)(A) 
reduction, B's $20,000 of section 1366(d) losses and deductions 
consisted of $8,000 of long-term capital losses, $7,000 of section 
1231 losses, and $5,000 of ordinary losses. After the section 
108(b)(2)(A) tax attribute reduction, X will allocate $3,750 of the 
excess deemed NOL to B. Under paragraph (d)(3) of this section, the 
$3,750 excess deemed NOL allocated to B consists of $1,500 of long-
term capital losses (($8,000/$20,000) x $3,750), $1,312.50 of 
section 1231 losses (($7,000/$20,000) x $3,750), and $937.50 of 
ordinary losses (($5,000/$20,000) x $3,750). As a result, at the 
beginning of 2010, B's $3,750 of section 1366(d)(2) carryovers 
consist of $1,500 of long-term capital losses, $1,312.50 of section 
1231 losses, and $937.50 of ordinary losses.
    Example 6. (i) A and B each own 50 percent of the shares of 
stock in X, a calendar year S corporation. On March 1, 2009, X 
realizes $12,000 of COD income and excludes this amount from gross 
income under section 108(a)(1)(A) for X's 2009 taxable year. On June 
30, 2009, A sells all of her shares of stock in X to C in a transfer 
not described in section 1041(a). X does not make a terminating 
election under section 1377(a)(2). The COD income (had it not been 
excluded) would have been allocated $3,000 to A, $6,000 to B, and 
$3,000 to C under section 1366(a). Prior to the section 108(b)(2)(A) 
reduction, for the taxable year of the discharge the shareholders 
have disallowed losses and deductions under section 1366(d) 
(including disallowed losses carried over to the current year under 
section 1366(d)(2)) in the following amounts: A--$5,000, B--$13,000, 
and C--$2,000. The combined $20,000 of disallowed losses and 
deductions for the taxable year of the discharge are treated as a 
current year net operating loss tax attribute of X under section 
108(d)(7)(B) (deemed NOL).
    (ii) Under section 108(b)(2)(A), X's $12,000 of excluded COD 
income reduces the $20,000

[[Page 56113]]

deemed NOL to $8,000. Therefore, X has an $8,000 excess net 
operating loss (excess deemed NOL) to allocate to its shareholders. 
Under paragraph (d)(2)(ii)(C) of this section, none of the $8,000 
excess deemed NOL is allocated to C because C's section 1366(d) 
losses and deductions immediately prior to the section 108(b)(2)(A) 
reduction ($2,000) do not exceed C's share of the excluded COD 
income for 2008 ($3,000). However, each of A's and B's respective 
section 1366(d) losses and deductions immediately prior to the 
section 108(b)(2)(A) reduction exceed each of A's and B's respective 
shares of the excluded COD income for 2009. A's excess amount is 
$2,000 ($5,000-$3,000) and B's excess amount is $7,000 ($13,000-
$6,000). Therefore, the total of all shareholders' excess amounts is 
$9,000. Under paragraph (d)(2) of this section, X will allocate 
$1,777.78 of the $8,000 excess deemed NOL to A ($8,000 x $2,000/
$9,000) and $6,222.22 of the $8,000 excess deemed NOL to B ($8,000 x 
$7,000/$9,000). However, because A transferred all of her shares of 
stock in X in a transaction not described in section 1041(a), A's 
$1,777.78 of section 1366(d) losses and deductions are permanently 
disallowed under paragraph (d)(2)(iii) of this section. Accordingly, 
at the beginning of 2010, B has $6,222.22 of section 1366(d)(2) 
carryovers and C has no section 1366(d)(2) carryovers.
    Example 7. The facts are the same as in Example 6, except that 
X, with the consent of A and C, makes a terminating election under 
section 1377(a)(2) upon A's sale of her stock in X to C. Therefore, 
the COD income (had it not been excluded) would have been allocated 
$6,000 to A, $6,000 to B, and $0 to C. Under paragraph (d)(2)(ii)(C) 
of this section, none of the $8,000 excess deemed NOL is allocated 
to A because A's section 1366(d) losses and deductions immediately 
prior to the section 108(b)(2)(A) reduction ($5,000) do not exceed 
A's share of the excluded COD income for 2009 ($6,000). However, 
each of B's and C's respective section 1366(d) losses and deductions 
immediately prior to the section 108(b)(2)(A) reduction exceed each 
of B's and C's respective shares of the excluded COD income for 
2009. B's excess amount is $7,000 ($13,000-$6,000), C's excess 
amount is $2,000 ($2,000-$0). Therefore, the total of all 
shareholders' excess amounts is $9,000. Under paragraph (d)(2) of 
this section, X will allocate $6,222.22 of the $8,000 excess deemed 
NOL to B ($8,000 x $7,000/$9,000) and $1,777.78 of the $8,000 excess 
deemed NOL to C. Accordingly, at the beginning of 2010, B has 
$6,222.22 of section 1366(d)(2) carryovers and C has $1,777.78 of 
section 1366(d)(2) carryovers.

    (f) Effective/applicability date--(1) Paragraphs (a), (b), (c), and 
Examples 1, 2, 3, and 4 of paragraph (e) of this section apply to 
discharges of indebtedness occurring on or after May 10, 2004.
    (2) Paragraph (d) and Examples 5, 6, and 7 of paragraph (e) of this 
section apply to discharges of indebtedness occurring on or after 
October 30, 2009.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 4. In Sec.  602.101, paragraph (b) is amended by adding the 
following entry in numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                 * * * *
1.108-7.................................................       1545-2155
 
                                 * * * *
------------------------------------------------------------------------


    Approved: October 21, 2009.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
Michael Mundaca,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E9-26152 Filed 10-29-09; 8:45 am]
BILLING CODE 4830-01-P