[Federal Register Volume 76, Number 226 (Wednesday, November 23, 2011)]
[Proposed Rules]
[Pages 72362-72367]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-30290]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-149625-10]
RIN 1545-BK03


Application of the Segregation Rules to Small Shareholders

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations under section 382 
of the Internal Revenue Code (Code). These proposed regulations provide 
guidance regarding the application of the segregation rules to public 
groups under section 382 of the Code. These regulations affect 
corporations.

DATES: Written or electronic comments and requests for a public hearing 
must be received by February 21, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-149625-10), room 
5203, Internal Revenue Service, P.O. Box 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-
149625-10), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-149625-10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Stephen R. Cleary, (202) 622-7750; concerning submission of comments or 
to request a public hearing, Oluwafunmilayo (Funmi) P. Taylor, (202) 
622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

1. Segregation and Aggregation--Statute, Legislative History, and 
Current Regulations

    Section 382 imposes a limitation on a corporation's use of net 
operating loss carryovers following a change in ownership. The 
legislative history explains that a limitation is necessary following a 
change in ownership because new shareholders otherwise would have an 
opportunity to contribute income-producing assets (or divert income 
opportunities) to the corporation, thus inappropriately accelerating 
the use of net operating loss carryovers. The section 382 limitation is 
intended to prevent a corporation from obtaining greater loss 
utilization than it could have achieved absent a change in ownership. 
S. Rep. No. 99-313 at 232 (1986).
    A loss corporation has an ownership change if the percentage of 
stock of a loss corporation that is owned by one or more 5-percent 
shareholders has increased by more than 50 percentage points over the 
lowest percentage of stock of the loss corporation owned by such 
shareholders at any time during the testing period (generally, a three-
year period). For purposes of section 382, the attribution rules of 
section 318(a)(2) apply, without limitation, to treat individuals as 
the owners of loss corporation stock. Pursuant to section 382(g)(4)(A), 
individual shareholders who own less than five percent of a loss 
corporation are aggregated and treated as a single 5-percent 
shareholder (a public group).
    The regulations extend the public group concept to situations in 
which a loss corporation is owned by one or more entities, as defined 
in Sec.  1.382-3(a) (generally, partnerships, corporations, estates, 
and trusts). If an entity directly or indirectly owns five percent or 
more of the loss corporation, that entity has its own public group if 
its owners who are not 5-percent shareholders own, in the aggregate, 
five percent or more of the loss corporation. (Such an entity is 
referred to as a 5-Percent Entity in this preamble.)
    The segregation rules, which are generally contained in Sec.  
1.382-2T(j), and the exceptions thereto, which are generally contained 
in Sec.  1.382-3(j), apply to certain transactions affecting ownership 
by the loss corporation's direct public group and by the public groups 
of a 5-Percent Entity. The application of the segregation rules results 
in the creation of a new public group in addition to the one (or more) 
that existed previously. That new group is treated as a new 5-percent 
shareholder that increases its ownership interest in the loss 
corporation.
    Section 382(g)(4)(B) mandates application of the segregation rules 
to transactions constituting equity structure shifts of the loss 
corporation. Generally, equity structure shifts are acquisitive asset 
reorganizations and recapitalizations under section 368. Section 
382(g)(3)(B) provides regulatory authority to treat public offerings 
and similar transactions as equity structure shifts. Pursuant to that 
authority, the current segregation rules, subject to the cash issuance 
and small issuance exceptions (described in this preamble), treat 
issuances of stock under section 1032, redemptions, and redemption-like 
transactions as segregation events. The segregation rules also apply to 
transfers of loss corporation stock by an individual 5-percent 
shareholder to public shareholders and a 5-Percent Entity's transfer of 
loss corporation stock to public shareholders.
    The small issuance and cash issuance exceptions exempt certain 
amounts of stock issuances from the segregation rules. Generally, the 
small issuance exception exempts the total amount of stock issued 
during a taxable year to the extent it does not exceed 10 percent of 
the total value of the corporation's

[[Page 72363]]

outstanding stock at the beginning of the taxable year or 10 percent of 
the class of stock issued and outstanding at the beginning of the 
taxable year (the small issuance limitation). However, the small 
issuance exception does not apply to any issuance of stock that, by 
itself, exceeds the small issuance limitation. If stock is issued 
solely for cash, the cash issuance exception exempts a percentage of 
the total stock issued equal to 50 percent of the aggregate percentage 
ownership interest of the public groups of the corporation immediately 
before the issuance. In determining the size of the issuance for this 
purpose, stock issued to 5-percent shareholders is taken into account. 
If the small issuance exception excludes only a portion of a stock 
issuance, the cash issuance exception may apply to the portion not 
excluded under the small issuance exception. Pursuant to a grant of 
regulatory authority in section 382(m)(4), the small issuance exception 
can apply to recapitalizations, but otherwise, neither exception 
applies to equity structure shifts.

2. Notice 2010-49

    Notice 2010-49, 2010-27 I.R.B. 10, invited public comment relating 
to possible modifications to the regulations under section 382 
regarding the treatment of shareholders who are not 5-percent 
shareholders (Small Shareholders). See Sec.  601.601(d)(2)(ii)(b).
    Notice 2010-49 describes two general approaches--the Ownership 
Tracking Approach and the Purposive Approach--and sets forth some of 
the policy considerations underlying each approach. Both approaches 
recognize that a primary abuse section 382 seeks to prevent involves an 
acquisition of loss corporation stock followed by the contribution of 
income-producing assets or the diversion of income-producing 
opportunities to the corporation. The two approaches differ, however, 
in the extent they seek to identify and limit their effect to 
circumstances in which that abuse is most likely to occur.
    Under the Ownership Tracking Approach, generally it is of no 
significance whether the shareholders who increase their ownership are 
Small Shareholders or 5-percent shareholders. This approach ensures 
that abusive transactions are addressed by tracking all changes in 
ownership without regard to their particular circumstances. Thus, any 
transaction that allows the corporation to track the increase in 
ownership interests held by Small Shareholders results in the 
segregation of Small Shareholders into a new public group, which is 
treated as a 5-percent shareholder. However, the Ownership Tracking 
Approach makes a concession to administrative convenience and 
acknowledges that ``public trading,'' which is the purchase by one 
Small Shareholder of stock from another Small Shareholder, should not 
be taken into account because it is unduly burdensome for a corporation 
to take into account all such transactions. See Sec.  1.382-
2T(e)(1)(ii).
    Consistent with the purpose of section 382, the Purposive Approach 
seeks to identify more specifically the circumstances in which abuses 
are likely to arise. This approach reflects the view that it is 
unnecessary to take into account all readily identifiable acquisitions 
of stock by Small Shareholders, because Small Shareholders generally 
are not in a position to acquire loss corporation stock in order to 
contribute income-producing assets or divert income-producing 
opportunities.
    The current regulations primarily reflect the Ownership Tracking 
Approach. Although certain provisions may seem to follow the Purposive 
Approach, their justification is nevertheless based upon the Ownership 
Tracking Approach. For example, the cash issuance exception of Sec.  
1.382-3(j)(3) reduces the segregation effect of an issuance of stock to 
Small Shareholders but is justified on the grounds that there is likely 
to be substantial overlap between Small Shareholders who acquire stock 
in such an issuance and the Small Shareholders who already own stock.

Explanation of Provisions

1. Overview

    The IRS and the Treasury Department received a range of comments in 
response to Notice 2010-49. Some comments endorsed substantial changes 
to the existing regulations, while others supported changes within the 
existing regulatory framework. One commenter supporting more modest 
changes to the existing regulations suggested that an overhaul of the 
current regulations likely would produce new uncertainties and 
complexities. Additionally, the comment observed that revisions 
allowing substantial infusions of capital into a loss corporation 
without section 382 implications would be counter to section 382 
policies.
    After consideration of the comments received, these regulations 
propose revisions following the Purposive Approach within the existing 
regulatory framework. Consistent with the Purposive Approach, these 
proposed regulations are intended to lessen the administrative burden 
and section 382 implications associated with transactions that are 
unlikely to implicate section 382 policy concerns. In general, these 
proposed regulations employ objective criteria to implement the 
Purposive Approach. The IRS and the Treasury Department believe that, 
where practicable, objective rules best serve the interests of loss 
corporations that desire certainty with respect to their section 382 
positions, and best serve the interests of the government in fairly and 
consistently administering a complex statutory scheme.
    Comments that embraced a more fundamental reform of the existing 
regulations were not incorporated into this proposal primarily because 
the approaches introduced significant subjectivity. For example, one 
commenter suggested that, subject to an anti-abuse rule, the 
segregation rules should not apply to redemption transactions. Another 
commenter suggested that if certain stock issuances and redemptions of 
Small Shareholders are sufficiently related, those transactions should 
be treated as public trading. These suggestions were not incorporated 
in favor of proposals that will provide greater certainty of result to 
the government and to loss corporations.

2. Proposed Revisions

A. Inapplicability of the Segregation Rules to Certain Secondary 
Transfers
    Several of the comments supported rendering the segregation rules 
inoperative to transfers of loss corporation stock to Small 
Shareholders by 5-Percent Entities or individuals who are 5-percent 
shareholders. These comments also supported relief from the segregation 
rules for transactions in which an ownership interest in a 5-Percent 
Entity is transferred to a public owner or a 5-percent owner who is not 
a 5-percent shareholder.
    The IRS and the Treasury Department agree that adoption of these 
exceptions is appropriate because these transactions do not introduce 
new capital into the loss corporation and because direct or indirect 
ownership of the loss corporation becomes less concentrated, thus 
diminishing the opportunity for loss trafficking. Furthermore, limiting 
the creation of additional public groups where loss trafficking is not 
implicated simplifies tax compliance and administration. Accordingly, 
these proposed regulations generally render the segregation rules 
inoperative to transfers of loss corporation stock to Small 
Shareholders by 5-Percent Entities or individuals who are 5-percent 
shareholders. In these

[[Page 72364]]

cases, the stock transferred will be treated as being acquired 
proportionately by the public groups existing at the time of the 
transfer. This rule also applies to transfers of ownership interests in 
5-Percent Entities to public owners and to 5-percent owners who are not 
5-percent shareholders.
B. Inapplicability of the Segregation Rules to Certain Redemptions
    Two of the comments supported limiting application of the 
segregation rules in the case of redemptions. These commenters observed 
that, generally, a loss corporation's redemption of its stock from 
Small Shareholders does not raise loss trafficking concerns because (i) 
the capital of the loss corporation is contracting, and (ii) Small 
Shareholders generally cannot traffic in losses. One comment supported 
a rule that would, subject to an anti-abuse rule, render the 
segregation rules inapplicable to all redemptions. In addition to 
supporting the inapplicability of the segregation rules to all 
redemptions, the comment supported an objective rule for exempting 
redemptions based upon the mechanics of the small issuance exception.
    In general, these proposed regulations adopt a rule based upon the 
mechanics of the small issuance exception to obviate the need for a 
subjective anti-abuse rule. Like the small issuance exception, this 
exception for redemptions exempts from segregation, at the loss 
corporation's option, either 10 percent of the total value of the loss 
corporation's stock at the beginning of the taxable year, or 10 percent 
of the number of shares of the redeemed class outstanding at the 
beginning of the taxable year. Where this exception applies, each 
public group existing immediately before the redemption will be treated 
as redeeming its proportionate share of exempted stock.
    Like the small issuance exception, the small redemption exception 
will allow a loss corporation to plan its affairs as of the beginning 
of each taxable year. Furthermore, consistent with the Purposive 
Approach, the exception reduces administrative burden and the section 
382 impact of transactions in which the abuses that section 382 is 
intended to prevent are unlikely to arise.
C. Inapplicability of the Segregation Rules to 5-Percent Entities in 
Certain Circumstances
    One commenter expressed the need for relief from tracking shifts of 
ownership by Small Shareholders of 5-Percent Entities. The comment 
expressed that, in many cases, a loss corporation cannot obtain 
information relating to this ownership--either because the entity 
chooses not to respond or because the entity is prohibited from sharing 
information regarding its owners with the loss corporation. The 
inability to obtain this information may restrict capital-raising 
activities beyond what section 382 requires, because the loss 
corporation may choose to make worst-case assumptions about shifts in 
ownership when the relevant information cannot be obtained. The IRS and 
the Treasury Department agree that it is appropriate to provide relief 
in situations in which tracking shifts in ownership by Small 
Shareholders does not further the policy objectives of section 382. 
Furthermore, the IRS and the Treasury Department recognize that 
application of the segregation rules and the exceptions thereto present 
compliance issues for taxpayers and issues of tax administration for 
the government. Accordingly, these proposed regulations limit the 
situations in which the segregation rules apply to situations that 
potentially implicate the policies underlying section 382.
    Under these proposed regulations, the segregation rules will not 
apply to a transaction if, on a testing date on which the rules would 
otherwise apply (i) the 5-Percent Entity owns ten percent or less (by 
value) of all the outstanding stock of the loss corporation (the 
ownership limitation), and (ii) the 5-Percent Entity's direct or 
indirect investment in the loss corporation does not exceed 25 percent 
of the entity's gross assets (the asset threshold). For purposes of the 
asset threshold, the entity's cash and cash items within the meaning of 
section 382(h)(3)(B)(ii) are not taken into account. Generally, the 
loss corporation may establish the ownership limitation through either 
actual knowledge or, absent actual knowledge to the contrary, the 
presumptions regarding stock ownership in Sec.  1.382-2T(k)(1).
    The IRS and the Treasury Department believe that the proposal 
strikes an appropriate balance between reducing complexity and 
safeguarding section 382 policies. The proposal will enable loss 
corporations to disregard indirect changes in its ownership that may, 
under the current regulations, require burdensome information gathering 
and may unnecessarily impede the loss corporation's ability to 
reorganize its affairs. At the same time, however, the proposal imposes 
criteria that protect the government's interests. The asset threshold 
makes it unlikely that the loss corporation's attributes motivate 
transactions in the equity of 5-Percent Entities. Additionally, like 
the small issuance exception and the relief for redemptions that 
appears elsewhere in this proposal, the ownership limitation makes it 
unlikely that transactions among Small Shareholders one or more tiers 
removed from the loss corporation implicate loss trafficking concerns. 
(Note that the asset threshold and the ownership limitation do not 
apply to the exception for secondary transfers described elsewhere in 
this preamble because secondary transfers do not implicate the same 
policy concerns as transactions in which loss corporations can obtain 
additional capital.)
D. Clarification of Sec.  1.382-2T(j)(3)
    Section 1.382-2T(j)(3) provides that, in general, the segregation 
rules apply to sales of loss corporation stock by individual 5-percent 
shareholders and by first tier entities. This section further provides 
that the ``principles'' of the foregoing apply to ``transactions in 
which an ownership interest in a higher tier entity that owns five 
percent or more of the loss corporation (without regard to Sec.  1.382-
2T(h)(i)(A)) or a first tier entity is transferred to a public owner or 
a 5-percent owner who is not a 5-percent shareholder.'' This proposed 
regulation clarifies that the segregation rules apply to such a 
transfer only if the seller indirectly owns five percent or more of the 
loss corporation. In the case of a sale by an entity, ownership is 
determined without regard to Sec.  1.382-2T(h)(i)(A).
E. Small Issuance and Cash Issuance Exceptions
    Several of the comments requested expansion of the small issuance 
and cash issuance exceptions as a percentage of stock that is exempted 
from the segregation rules. Some of these comments also suggested that 
the cash issuance exception should apply to issuances of stock for non-
cash property, including debt.
    As previously discussed, transactions that infuse new capital into 
a loss corporation are of particular concern to section 382 policies 
because the capital infusion can accelerate the use of tax attributes. 
This is the case even if the new investors are Small Shareholders. 
Moreover, in its current form, the cash issuance exception dilutes the 
owner shifts that are attributable to capital-raising transactions.
    The IRS and the Treasury Department request comments as to whether 
further refinement of either or both of these exceptions might be 
warranted in the context of any potential expansion of

[[Page 72365]]

the exceptions proposed in this document.
F. Coordinated Acquisitions
    Questions have arisen concerning the application of Sec.  1.382-
3(a), which provides, in part, that a group of persons making a 
coordinated acquisition of stock can constitute an entity for purposes 
of section 382. Adding additional distinctions between larger and 
smaller shareholders, as proposed here, will increase the significance 
of this provision. The IRS and the Treasury Department are interested 
in comments as to circumstances under which a group of investors should 
be aggregated into a single entity based on their understandings or 
communications with each other or with third persons, such as the loss 
corporation or an underwriter.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13563. Therefore, a 
regulatory assessment is not required. It is hereby certified that 
these regulations will not have a significant economic impact on a 
substantial number of small entities. The certification is based on the 
fact that this rule would not impose new burdens on small entities and 
in fact, may reduce the recordkeeping burden on small entities. 
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, this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Request for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. In addition to the specific requests for comments made 
elsewhere in this preamble, the IRS and the Treasury Department 
specifically request comments on the clarity of the proposed 
regulations and how they may be made easier to understand. All comments 
will be available for public inspection at http://www.regulations.gov 
or upon request. A public hearing may be scheduled if requested in 
writing by any person who timely submits written comments. If a public 
hearing is scheduled, notice of the date, time, and place of the 
hearing will be published in the Federal Register.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed 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 continues to read in 
part as follows:

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

    Section 1.382-3 also issued under 26 U.S.C. 382(g)(4)(C) and 26 
U.S.C. 382(m). * * *

    Par. 2. Section 1.382-3 is amended as follows:
    1. Adding paragraph (i).
    2. Revising the heading of paragraph (j) and the introductory text 
of paragraph (j)(1).
    3. Redesignating paragraphs (j)(13) and (j)(14) as (j)(16) and 
(j)(17).
    4. Adding new paragraphs (j)(13) through (j)(14).
    5. Adding new Examples 5, 6, 7, 8, 9, 10, 11, and 12 to newly 
redesignated paragraph (j)(16).
    6. Revising newly redesignated paragraph (j)(17).
    The revisions and additions read as follows:


Sec.  1.382-3  Definitions and rules relating to a 5-percent 
shareholder.

* * * * *
    (i) Segregation rules applicable to transactions involving first 
tier or higher tier entities--(1) In general. The last sentence of 
Sec.  1.382-2T(j)(3)(i) applies only if the transferor of the ownership 
interest indirectly owns five percent or more of the loss corporation. 
If the transferor is an entity, ownership is determined without regard 
to the application of Sec.  1.382-2T(h)(2)(i)(A).
    (2) Effective/Applicability date. This paragraph (i) applies to 
testing dates occurring on or after the date these regulations are 
published as final regulations in the Federal Register.
    (j) Modification of the segregation rules of Sec.  1.382-
2T(j)(2)(iii) and (3)--(1) Introduction. This paragraph (j) exempts, in 
whole or in part, certain transfers of stock from the segregation rules 
of Sec.  1.382-2T(j)(2)(iii) and (3). Terms and nomenclature used in 
this paragraph (j), and not otherwise defined herein, have the same 
meanings as in section 382 and the regulations issued under section 
382.
* * * * *
    (13) Secondary transfer exception. The segregation rules of Sec.  
1.382-2T(j)(3)(i) will not apply to the transfer of a direct ownership 
interest in the loss corporation by a first tier entity or an 
individual that owns five percent or more of the loss corporation to 
public shareholders. Instead, each public group existing at the time of 
the transfer will be treated under Sec.  1.382-2T(j)(3)(i) as acquiring 
its proportionate share of the stock exempted from the application of 
Sec.  1.382-2T(j)(3)(i). The segregation rules also will not apply if 
an ownership interest in an entity that owns five percent or more of 
the loss corporation (determined without regard to the application of 
Sec.  1.382-2T(h)(2)(i)(A)) is transferred by either a 5-percent owner 
that is a 5-percent shareholder or a higher tier entity owning five 
percent or more of the loss corporation (determined without regard to 
the application of Sec.  1.382-2T(h)(2)(i)(A)), provided that the 
transferee is either a public owner or a 5-percent owner who is not a 
5-percent shareholder. Instead, each public group of the entity 
existing at the time of the transfer is treated under Sec.  1.382-
2T(j)(3)(i) as acquiring its proportionate share of the transferred 
ownership interest.
    (14) Small redemption exception--(i) In general. Section 1.382-
2T(j)(2)(iii)(C) does not apply to a small redemption (as defined in 
paragraph (j)(14)(ii) of this section), except to the extent that the 
total amount of stock redeemed in that redemption and all other small 
redemptions previously made in the same taxable year (determined in 
each case on redemption) exceeds the small redemption limitation. This 
paragraph (j)(14) does not apply to a redemption of stock that, by 
itself, exceeds the small redemption limitation.
    (ii) Small redemption defined. Small redemption means a redemption 
of public shareholders by the loss corporation of an amount of stock 
not exceeding the small redemption limitation.
    (iii) Small redemption limitation--(A) In general. For each taxable 
year, the loss corporation may, at its option, apply this paragraph 
(j)(14)--
    (1) On a corporation-wide basis, in which case the small redemption

[[Page 72366]]

limitation is 10 percent of the total value of the loss corporation's 
stock outstanding at the beginning of the taxable year (excluding the 
value of stock described in section 1504(a)(4)); or
    (2) On a class-by-class basis, in which case the small redemption 
limitation is 10 percent of the number of shares of the class redeemed 
that are outstanding at the beginning of the taxable year.
    (B) Class of stock defined. For purposes of this paragraph 
(j)(14)(iii), a class of stock includes all stock with the same 
material terms.
    (C) Adjustments for stock splits and similar transactions. 
Appropriate adjustments to the number of shares of a class outstanding 
at the beginning of a taxable year must be made to take into account 
any stock split, reverse stock split, stock dividend to which section 
305(a) applies, recapitalization, or similar transaction occurring 
during the taxable year.
    (D) Exception. The loss corporation may not apply this paragraph 
(j)(14)(iii) on a class-by-class basis if, during the taxable year, 
more than one class of stock is redeemed in a single redemption (or in 
two or more redemptions that are treated as a single redemption under 
paragraph (j)(14)(v) of this section).
    (E) Short taxable years. In the case of a taxable year that is less 
than 365 days, the small redemption limitation is reduced by 
multiplying it by a fraction, the numerator of which is the number of 
days in the taxable year, and the denominator of which is 365.
    (iv) Proportionate redemption of exempted stock--(A) In general. 
Each direct public group that exists immediately before a redemption to 
which this paragraph (j)(14) applies is treated as having been redeemed 
of its proportionate share of the amount of stock exempted from the 
application of Sec.  1.382-2T(j)(2)(iii)(C) under this paragraph 
(j)(14).
    (B) Actual knowledge of greater redemption. Under the last sentence 
of Sec.  1.382-2T(k)(2), the loss corporation may treat direct public 
groups existing immediately before a redemption to which this paragraph 
(j)(14) applies as having been redeemed of more stock than the amount 
determined under paragraph (j)(14)(iv)(A) of this section, but only if 
the loss corporation actually knows that the amount redeemed from those 
groups in the redemption exceeds the amount so determined.
    (v) Certain related redemptions. For purposes of this paragraph 
(j)(14), two or more redemptions (including redemptions of stock by 
first tier or higher tier entities) are treated as a single redemption 
if--
    (A) The redemptions occur at approximately the same time pursuant 
to the same plan or arrangement; or
    (B) A principal purpose of redeeming the stock in separate 
redemptions rather than in a single redemption is to minimize or avoid 
an owner shift under the rules of this paragraph (j)(14).
    (vi) Certain non-stock ownership interests. As the context may 
require, a non-stock ownership interest in an entity other than a 
corporation is treated as stock for purposes of this paragraph (j)(14).
    (15) Exception for first tier and higher tier entities--(i) In 
general. The segregation rules of Sec.  1.382-2T(j)(3)(iii) will not 
apply if, after taking into account the results of such transaction and 
all other transactions occurring on that date--
    (A) The first tier or higher tier entity owns 10 percent or less 
(by value) of all the outstanding stock (without regard to Sec.  1.382-
2(a)(3)) of the loss corporation; and
    (B) The entity's direct or indirect investment in the loss 
corporation does not exceed 25 percent of the entity's gross assets. 
For this purpose, the entity's cash and cash items within the meaning 
of section 382(h)(3)(B)(ii) are not taken into account.
    (ii) Special Rules. If paragraph (j)(15)(i) applies to combine one 
or more public groups, then--
    (A) the amount of increase in the percentage of stock ownership of 
the continuing public group will be the sum of its increase and a 
proportionate amount of any increase by any public group that is 
combined with the continuing public group (the former public group); 
and
    (B) the continuing public group's lowest percentage ownership will 
be the sum of its lowest percentage ownership and a proportionate 
amount of the former public group's lowest percentage ownership.
    (iii) Ownership of the loss corporation. In making the 
determination under paragraph (j)(15)(i)(A) of this section--
    (A) The rules of Sec.  1.382-2T(h)(2) will not apply;
    (B) The entity will be treated as owning the loss corporation stock 
that it actually owns, and any loss corporation stock if that stock 
would be attributed to the entity under section 318(a) (without regard 
to paragraph (4) thereof unless an option is treated as exercised under 
Sec.  1.382-4(d)); and
    (C) The operating rules of paragraph (j)(15)(iv) of this section 
will apply.
    (iv) Operating Rules. Subject to the principles of Sec.  1.382-
2T(k)(4), a loss corporation may establish the ownership limitation of 
paragraph (j)(15)(i)(A) of this section through either--
    (A) Actual knowledge; or
    (B) Absent actual knowledge to the contrary, the presumptions 
regarding stock ownership in Sec.  1.382-2T(k)(1).
    (16) Examples. * * *
* * * * *
    Example 5. Secondary transfer exception to segregation rules--no 
new public group. (i) Facts. L is owned 60 percent by one public 
group (Public L1) and 40 percent by another public group 
(Public L2). On July 1, 2010, A acquires 10 percent of 
L's stock over a public stock exchange. On December 31, 2010, A 
sells all of his L stock over a public stock exchange. No individual 
or entity acquires as much as five percent of L's stock as a result 
of A's disposition of his L stock. On January 3, 2011, B acquires 10 
percent of L's stock over a public stock exchange. On June 30, 2011, 
B sells all of her L stock over a public stock exchange. No 
individual or entity acquires as much as five percent of L's stock 
as a result of B's disposition of her L stock.
    (ii) Analysis. The dispositions of the L stock by A and B are 
not transactions that cause the segregation of L's direct public 
groups that exist immediately before the transaction (Public 
L1 and Public L2). When A and B sell their 
shares to public shareholders over the public stock exchange, the 
shares are treated as being reacquired by Public L1 and 
Public L2. As a result, Public L1's ownership 
interest is treated as increasing from 54 percent to 60 percent 
during the testing period, and Public L2's ownership 
interest is treated as increasing from 36 percent to 40 percent 
during the testing period.
    Example 6. Secondary transfer exception--first tier entity. (i) 
Facts. L has a single class of common stock outstanding that is 
owned 60 percent by a direct public group (Public L) and 40 percent 
by P. P is owned 20 percent by Individual A and 80 percent by a 
direct public group (Public P). On October 6, 2013, A sells 50 
percent of his interest in P to B, an individual who is a member of 
Public P.
    (ii) Analysis. P is an entity that owns five percent or more of 
L. A is a 5-percent owner of P that is a 5-percent shareholder of L. 
Because A's sale of the P stock is to a member of Public P, the 
disposition of the P stock by A is not a transaction that causes the 
segregation of P's direct public group that exists immediately 
before the transaction (Public P). See paragraph (j)(13) of this 
section. When A sells his shares to B, the shares are treated as 
being acquired by Public P. As a result, Public P's ownership 
interest in L is treated as increasing from 32 percent to 36 percent 
during the testing period.
    Example 7. Small redemption exception. (i) Facts. L is a 
calendar year taxpayer. On January 1, 2010, L has 1,060 shares of a 
single class of common stock outstanding, all of which are owned by 
a single direct public group (Public L). On July 1, 2010, L acquires 
60 shares of its stock for cash. On December 31, 2010, in an 
unrelated redemption, L acquires 90 more shares of its stock for 
cash. Following each redemption, L's stock is

[[Page 72367]]

owned entirely by public shareholders. No other changes in the 
ownership of L's stock occur prior to December 31, 2010.
    (ii) Analysis. The July redemption is a small redemption because 
the number of shares redeemed (60) does not exceed 106, the small 
redemption limitation (10 percent of the number of common shares 
outstanding on January 1, 2010). Under paragraph (j)(14) of this 
section, the segregation rules of Sec.  1.382-2T(j)(2)(iii)(C) do 
not apply to the July redemption. Under paragraph (j)(14)(iv) of 
this section, Public L is treated as having all 60 shares redeemed.
    (iii) The December redemption is a small redemption because the 
number of shares redeemed (90) does not exceed 106, the small 
redemption limitation (10 percent of the number of common shares 
outstanding on January 1, 2010). However, under paragraph (j)(14)(i) 
of this section, only 46 of the 90 shares redeemed are exempted from 
the segregation rules of Sec.  1.382-2T(j)(2)(iii)(C) because the 
total number of shares of common stock redeemed in the July and 
December redemptions exceeds 106, the small redemption limitation, 
by 44. Accordingly, under paragraph (j)(14)(iv) of this section, 
Public L is treated as having 46 shares redeemed in the December 
redemption. Section 1.382-2T(j)(2)(iii)(C) applies to the remaining 
44 shares redeemed. Accordingly, Public L is segregated into two 
different public groups immediately before the transaction (and 
thereafter) so that the redeemed interests (Public RL) are treated 
as part of a public group that is separate from the ownership 
interests that are not redeemed (Public CL). Therefore, as a result 
of the December redemption, Public CL's interest in L increases by 
4.4 percentage points (from 95.6 percent (956/1,000) to 100 percent 
(910/910)) on the December 31, 2010 testing date. For purposes of 
determining whether an ownership change occurs on any subsequent 
testing date having a testing period that includes such redemption, 
Public CL is treated as a 5-percent shareholder whose percentage 
ownership interests in L increased by 4.4 percentage points as a 
result of the redemption.
    Example 8. Segregation rules inapplicable--proportionate amount. 
(i) Facts. P1 is a corporation that owns 8 percent of the 
stock of L. The remaining L stock (92 percent) is owned by Public L. 
P1 is entirely owned by Public P1. Excluding 
cash and cash items within the meaning of section 382(h)(3)(B)(ii), 
P1's investment in L represents 11 percent of 
P1's gross assets. P2 is a corporation owned 
90 percent by individual A and 10 percent by a public group (Public 
P2). On May 22, 2013, P1 merges into 
P2 with the shareholders of P1 receiving an 
amount of P2 stock equal to 25 percent of the value of 
P2 immediately after the reorganization. Following the 
merger, P2's investment in L represents 6 percent of the 
combined gross assets of P1 and P2 (excluding 
cash and cash items). L was owned 92 percent by Public L and 8 
percent by P1 throughout the testing period ending on the 
date of the merger.
    (ii) Analysis. Assuming L can establish that P2 owns 
10 percent or less (by value) of L on May 22, 2013 pursuant to the 
operating rules of paragraph (j)(15)(iv) of this section, the 
segregation rules of Sec.  1.382-2T(j)(3)(iii) will not apply to 
segregate P1's direct public group (Public P1) 
immediately before the merger from P2's direct public 
group (Public P2). Thus, following the merger, 
P2 is owned 67.5 percent (90% x 75%) by A and 32.5 
percent (25% + (10% x 75%)) by Public P2. Pursuant to 
paragraph (j)(15)(ii)(B) of this section, Public P2's 
lowest percentage of ownership is the sum of its lowest percentage 
of ownership (zero) and a proportionate amount of former Public 
P1's lowest ownership percentage of L of 2.6 percent 
(32.5% x 8%). P2 will be treated as having one public 
group whose ownership interest in L was 2.6 percent before the 
merger and remains 2.6 percent after the merger. Because Public 
P2 owns less than 5 percent of L, Public P2 is 
treated as part of Public L. See Sec.  1.382-2T(j)(1)(iv). Thus, 
pursuant to paragraph (j)(15)(ii)(B) of this section, Public L's 
lowest ownership percentage of L during the testing period is 94.6 
percent.
    Example 9. Segregation rules inapplicable--prior increase in 
ownership by former public group during testing period. (i) Facts. 
The facts are the same as Example 8, except that P1 
acquired its 8 percent interest in L during the testing period that 
includes the merger.
    (ii) Analysis. Pursuant to the rules of paragraph (j)(15)(ii)(A) 
of this section, the amount of increase in the percentage of stock 
ownership by Public P2 is the sum of its increase and any 
increase by a former public group (Public P1). 
Accordingly, Public P2, the continuing public group, is 
treated as having increased its ownership interest by 2.6 percent, 
and Public L is treated as increasing its ownership interest by 2.6 
percent.
    Example 10. Ownership limitation based upon fair market value. 
(i) Facts. L has two classes of stock outstanding, common stock and 
preferred stock. The preferred stock is stock within the meaning of 
Sec.  1.382-2(a)(3). A direct public group (Public L) owns all of 
the common stock of L. P purchased 100 percent of the preferred 
stock of L at a time when the preferred stock represented 9 percent 
of the value of all the outstanding stock of L. The common stock 
owned by Public L represents the remaining 91 percent of the value 
of the stock of L. P has one class of common stock outstanding, all 
of which is owned by a direct public group (Public P). On October 7, 
2013, P redeems 30 percent of its single outstanding class of common 
stock. Due to a decline in the relative value of the common stock of 
L, the preferred stock of L represents 40 percent of the value of 
all the outstanding stock of L on the date of the redemption.
    (ii) Analysis. The rules of paragraph (j)(15) of this section do 
not apply to the redemption because P owns more than 10 percent of L 
(by value) on that date.
    Example 11. Ownership limitation--fair market value includes 
preferred stock. The facts are the same as in Example 10, except 
that the preferred stock is not stock within the meaning of Sec.  
1.382-2(a)(3). The results are the same as in Example 10.
    Example 12. Ownership limitation--application of attribution 
rules. (i) Facts. Individual A owns all the outstanding stock of X. 
A also owns preferred stock in Y that is not stock within the 
meaning Sec.  1.382-2(a)(3), which represents 50 percent of the 
value of Y. All the Y common stock is owned by public owners. Each 
of X and Y own 6 percent of the single class of L stock outstanding. 
On October 6, 2013, Y redeems 15 percent of its common stock.
    (ii) Analysis. In determining the ownership limitation of this 
paragraph, the attribution rules of section 318(a) apply. Pursuant 
to section 318(a)(2), A is treated as owning the L stock owned by X. 
Pursuant to section 318(a)(3), Y is treated as owning the L stock 
that A indirectly owns. Because Y's ownership of L exceeds the 
ownership limitation, the rules of paragraph (j)(15) of this section 
do not apply.

    (17) Effective/applicability date. This paragraph (j) generally 
applies to issuances or deemed issuances of stock in taxable years 
beginning on or after November 4, 1992. However, paragraphs (j)(13) 
through (j)(15) and Examples 5 through 12 of paragraph (j)(16) apply to 
testing dates occurring on or after the date these regulations are 
published as final regulations in the Federal Register. See Sec.  
1.382-3(j)(14)(ii) and (iii), as contained in 26 CFR part 1 revised as 
of April 1, 1994, for the application of paragraph (j)(10) to stock 
issued on the exercise of certain options exercised on or after 
November 4, 1992 and for an election to apply paragraphs (j)(1) through 
(12) retroactively to certain issuances and deemed issuances of stock 
occurring in taxable years prior to November 4, 1992.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-30290 Filed 11-22-11; 8:45 am]
BILLING CODE 4830-01-P