Acquisitions of Troubled

Corporations

October 31, 2012

Tulane Tax Institute

New Orleans, LA

Don Leatherman

University of Tennessee

Knoxville, TN

Overview

• Section 382

– Section 382(l)(6)

– The cash-issuance exception to the

segregation rule

• The SRLY rules

• Consolidated attribute reduction

• The unified loss rules

2

Section 382(l)(6)

Section 382

• Section 382 applies to an ownership change of a loss corporation, loss group, or loss subgroup.

• Broadly speaking, an ownership change requires a 50 percentage point change in stock ownership of 5-percent shareholders over a three-year period. See § 382(g)(1).

• Under § 382(a), if a loss corporation has an ownership change, the amount of its income that may be offset by "pre-change" losses in any "post-change" year cannot exceed the § 382 limitation.

4

Section 382 limitation

• The § 382 limitation equals (i) the value of

the loss corporation immediately before

the ownership change, multiplied by (ii) the

applicable federal long-term tax-exempt

rate.

• Under § 382(e), the value of the loss

corporation generally equals the value of

its stock immediately before the ownership

change.

5

Section 382(l)(6) – in general

• If § 382(l)(6) applies, the loss corporation’s value equals the smaller of -- – The value of its stock immediately after the ownership

change; or

– The gross value of its pre-change assets.

§ 1.382-9(j).

• Section 382(l)(6) applies if – – An ownership change occurs pursuant to a plan of

reorganization in a title 11 or similar case, and

– Section 382(l)(5) does not apply (by election or otherwise).

6

Computing stock and gross asset

values

• Both the stock and gross asset values may be reduced to account for substantial non-business assets. See § 382(l)(4).

• The stock value is also reduced to account for redemptions connected to the ownership change (§ 382(e)(2)), but the anti-stuffing rule of § 382(l)(1) does not apply. § 1.382-9(k).

• To determine the loss corporation’s gross asset value, the anti-stuffing rule applies but the redemption rule does not. § 1.382-9(k).

7

Consolidated issues

• No regulations have been issued describing how § 382(l)(6) (or § 382(l)(5)) applies to a consolidated group.

• A single-entity approach would be consistent with the consolidated computation of income and loss.

• A separate-corporation approach would be consistent with each member having distinct creditors and being entitled to separate bankruptcy protection.

8

Basic Application of §382(l)(6)

• Bankrupt T has liabilities of $150 and gross assets with a FMV of $100

• Under bankruptcy plan: – Old equity of T is cancelled

– New equity issued to Buyer for $100

– Lenders receive $100 in full satisfaction of their claims

• Under § 382(l)(6), annual § 382 limit = $100 x 4%

Buyer T $100

Lenders

Debt

$150

New Equity

$100

$100 FMV

9

Consolidated Application of

§382(l)(6): Parent Bankrupt

• Bankrupt P has liabilities of $50; its only asset is the stock of non-bankrupt S, which has liabilities of $70 and gross assets with a FMV of $100

• Does consolidated group get to avail itself of §382(l)(6)? – See PLR 201051019

• Can Buyer enhance § 382 limit by paying $100 to enable S to payoff liabilities? – Answer different if S converts to

LLC first?

Buyer P $30

Lenders

Debt

$50

New Equity

$30

S

$100 FMV

$70 liabilities

10

Consolidated Application of

§382(l)(6): Subsidiary Bankrupt

• Non-bankrupt P owns Bankrupt S, which has liabilities of $150 and gross assets with a FMV of $100; Buyer holds all of the S debt

• Buyer agrees to cancel S Debt in exchange for P stock

• Does consolidated group get to avail itself of § 382(l)(6)? – See PLR 8849061

• Answer different if P voluntarily submits itself to jurisdiction of bankruptcy court?

• What if S is a disregarded entity? – Cf. Prop. § 1.108-9

Buyer P

S Debt

$150 S

$100 FMV

P Stock

11

Aggregation and Segregation

Rules --

the Cash-issuance Exception

Section 382 in general

Section 382 applies if a loss corporation undergoes an ownership change, which occurs if the percentage of loss corporation stock owned by one or more 5-percent shareholders increases by more than 50 percentage points over the testing period. § 382(g) (defining ownership change).

– For this purpose, the loss corporation's § 1504(a)(4) stock (i.e., its pure vanilla preferred stock) is disregarded. § 382(k)(6).

13

5-percent shareholders

• A 5-percent shareholder includes any

individual owning 5 percent or more in

value of corporate stock at any time during

the testing period. § 382(k)(7).

• Section 318, with modifications, applies to

determine stock ownership. See generally

§ 382(l)(3).

14

Aggregation rule

Generally under the aggregation rule, each

individual that holds (directly and through

attribution) less than 5 percent of the loss

corporation’s stock is aggregated into a

“residual” public group.

– That group is treated as a single 5-percent

shareholder. § 1.382-2T(j)(1).

15

Segregation rules

• Shareholders of higher-tier corporations. § 1.382-2T(j)(1)(iv).

• Equity structure shifts. § 1.382-2T(j)(2)(iii)(B)(i).

• Stock issued to non-5 percent shareholders in a public or private offering. § 1.382-2T(j)(2)(iii)(B)(ii). Exceptions – – Small issuance exception. § 1.368-3(j)(2) and (6).

– Cash issuance exception – if a loss corporation issues stock for cash to the public, any existing public group is deemed to acquire a fraction of that newly issued stock equal to one-half of the percentage the group owned immediately before the issuance. § 1.382-3(j)(3)(i).

16

Example – cash-issuance exception

• L sells $300 worth of

stock to the public.

• After the sale, no

shareholder other than

A or B is a 5-percent

shareholder.

• Has an ownership

change occurred?

17

L

Public group A B

60% 20% 20%

L, a loss corporation, has

a $100 value.

It has one class of stock outstanding.

L stock

Public

$300

Consequences

The stock offering results in an ownership change for L.

– A 75% interest ($300/$400) interest in the L stock is issued in the stock offering.

– Under the cash-issuance exception, the existing public group is deemed to acquire a 22.5% block of stock (½ * 60% * 75%).

– A new public group is deemed to acquire a 52.5% block of stock (75% minus 22.5%).

– Because immediately after the stock offering, the new public group has increased its percentage ownership in L by more than 50 percentage points, an ownership change has occurred.

18

Example – redemption-type

transaction

• B exchanges her stock for L preferred stock and warrants

• L sells $300 worth of common stock to the public.

• After the sale, no shareholder other than A or B is a 5-percent shareholder.

• Has an ownership change occurred?

19

L

Public group A B

60% 20% 20%

L, a loss corporation, has

a $100 value.

It has one class of stock outstanding.

L common

stock

Public

$300

75% 25% Pref. st . +

warrants

Option treated as stock

• To determine if an ownership change occurs, an option may be considered exercised when issued if on that date it satisfies an ownership, control, or income test. § 1.382-4(d)(2)(i).

• To satisfy any of these tests, the option must be issued with a principal purpose to avoid or ameliorate the impact of an ownership change of the loss corporation. Further -- – To satisfy the ownership test, the option must provide the holder

with a substantial portion of the ownership of the underlying stock.

– To satisfy the control test, the holders of the option and related persons must also directly and indirectly own more than 50 percent of the loss corporation, assuming that all options they hold are exercised.

– To satisfy the income test, the option must also facilitate the creation of income or value before the exercise or transfer of the option.

§ 1.382-4(d)(3)-(6). 20

Example – redemption-type

transaction

• B exchanges her stock for L preferred stock and warrants

• L sells $300 worth of common stock to the public.

• After the sale, no shareholder other than A or B is a 5-percent shareholder.

• Has an ownership change occurred? See PLR 201126002.

21

L

Public group A B

75% 25%

L, a loss corporation, has

a $100 value.

L common

stock

Public

$300

Pref. st. +

warrants

SRLY Rules

Cumulative contribution

• The portion of a member's SRLY losses that may be included in the consolidated net operating loss (“CNOL”) cannot exceed the member's aggregate contribution to consolidated taxable income (“CTI”), determined by taking into account only the member's items. § 1.1502-21(c)(1)(i).

• For this purpose, the group takes into account only those years that the member has been continuously included in the group.

§ 1.1502-21(c)(1)(i)(C). • Note that for a carryback, the group takes into account any

year beginning after 1996 or, by election, for any year beginning after January 28, 1991.

23

SRYs and SRLYs

• A separate return year or SRY is a taxable year for which the member files a separate return or joins in the filing of a consolidated return with another group. § 1.1502-1(e).

• Generally, a separate return limitation year or SRLY is any SRY of a member or its predecessor. § 1.1502-1(f)(1).

– There are exceptions for losses arising in SRYs of the common parent and in separate return but affiliated years of a subsidiary. § 1.1502-1(f)(2).

24

The overlap rule -- in general

• The SRLY limitation does not apply if the overlap rule applies. § 1.1502-21(g)(1).

• An overlap occurs for an NOL if a corporation becomes a consolidated group member within six months of a § 382 ownership change with respect to the loss.

§ 1.1502-21(g)(2)(ii)(A).

• If the SRLY event follows the § 382 event, the overlap rule also applies to any "interim" NOL. § 1.1502-21(g)(2)(ii)(B).

25

Timing of the SRLY and § 382

events • If the SRLY event occurs on the date of, or

following, the § 382 event, the overlap rule applies beginning with the taxable year that includes the SRLY event. § 1.1502-21(g)(3)(i).

• If the SRLY event precedes the § 382 event, the overlap rule applies starting with the first taxable year that begins after the § 382 event. § 1.1502-21(g)(3)(ii). – Thus, the SRLY limitation applies to the NOL

during the interim between the two events.

26

Subgroups

• If there is a SRLY subgroup connected with a SRLY loss, the SRLY principles apply to the subgroup. § 1.1502-21(c)(2). – Thus, the subgroup's SRLY limitation is computed

by taking into account the subgroup's tax items.

• For a SRLY carryback, the SRLY subgroup includes the loss member and each other corporation that has been "continuously affiliated" with the loss member from the year to which the loss is carried through the loss year. § 1.1502-21(c)(2)(ii).

27

Subgroups (cont'd)

• For a SRLY carryover, a SRLY subgroup includes the loss member and each other member that was a member of the former group that becomes a member of the group "at the same time" as the loss member. § 1.1502-21(c)(2)(i). – Apparently, there is no requirement that SRLY

subgroup members be affiliated with each other immediately before they become members of the current group.

• Note that a SRLY subgroup need not have a subgroup "parent."

28

Subgroups and the overlap rule

• The overlap rule applies to a SRLY NOL for a SRLY subgroup if -- – There is also a § 382 subgroup; and

– The members of both subgroups are coextensive.

§ 1.1502-21(g)(4)(i).

• If the SRLY event follows the § 382 event for a SRLY subgroup, the SRLY limitation does not apply to an NOL arising between the two events if -- – The overlap rule applies to a SRLY NOL arising before the

§ 382 event, and

– All members of the SRLY subgroup for the interim NOL are also members of a SRLY subgroup for the pre-change NOL.

§ 1.1502-21(g)(4)(ii).

29

Section 382 subgroup

• A § 382 subgroup (called a “loss” subgroup in § 1.1502-91(d)) are "two or more corporations" that have the following characteristics: – They were affiliated with each other in another group (the

"former" group), whether or not the former group was a consolidated group;

– They bear a subgroup relationship to one another through a subgroup parent immediately after they become members of the current group; and

– At least one of the members carries over an NOL that did not arise or is not treated under the fold-in rule as arising in a SRLY with respect to the former group.

§ 1.1502-91(d)(1).

• The second of those requirements is deemed met if the common parent of the current group so elects. § 1.1502-91(d)(4).

30

Subgroups

31

A B

P, S, and T file a consolidated return in 2010

The group has a $10 loss that is attributed to S

In 2011, M, a creditor of S and T, succeeds to the stock of S and T

Are S and T a SRLY subgroup? A § 382 subgroup?

($10)

2010 2011

P

S T

M

A

P

B

M

S T

The fold-in rule

• If the fold-in rule of § 1.1502-96(a)(1) applies, a group no longer has to separately track a SRLY loss to measure future ownership changes under § 382.

• This rule applies to a member (or subgroup) with a SRLY loss when it joined the group if the member (or subgroup) -- – Has an ownership change within six months of joining the group; or

– Does not have an ownership change for the five-year period after it has joined the group.

• This rule applies on the earlier of – – The change date (or, if later, when the member or subgroup joined the

group), or

– The last day of the five-year period.

• Note that this rule is relevant to determine a § 382 subgroup after the fold-in event occurs.

32

Applying the fold-in rule

33

• F, a foreign corporation,

owns all X and Y stock.

• X and Y are common

parents of a consolidated

group

• In Year 1, the Y group has

a $100 CNOL, all

attributable to Y1.

On Jan. 1 of Year 2, F

contributes the Y stock

to X; Y and Y1 become

X group members.

In Year 3, the X group has

a $200 CNOL, all

attributable to Y1.

P, the common parent of

an unrelated consolidated

group, acquires the X

stock.

What happens if the sale

occurs on –

June 30 of Year 6?

June 30 of Year 7?

F

X

X1

Y

Y1

F

X

X1 Y

Y1

Consolidated

Attribute Reduction

35

Section 108: Attribute Reduction

• If a taxpayer excludes cancellation of indebtedness (“COD”) income under the bankruptcy or insolvency exception of § 108, it must reduce the following attributes in the following order: – NOLs for the year of discharge and NOL carryovers to

the year of discharge – General business credits – Minimum tax credits – Capital loss for the year of discharge and capital loss

carryovers to the year of discharge – Basis of property held on the first day of the following

year – Passive activity losses and credits – Foreign tax credits

36

Section 108(b): Elections and Special Rules

• Section 108(b)(5) allows a taxpayer to reduce basis in depreciable property before NOLs.

• Section 1017(b)(3)(D) permits a member of a consolidated group to treat stock that it holds in a subsidiary as depreciable property to the extent the subsidiary reduces the basis of its depreciable property.

• Section 1017(b)(2) limits the reduction to the basis of property such that the remaining basis is not less than the post-COD liabilities.

• One dollar of a credit is reduced for every three dollars of COD.

37

Section 108 (Cont’d)

• If the excluded COD income exceeds the amount of attributes available for reduction, the excess is permanently excluded (“black-hole COD”).

• Under § 108(b)(4)(A), reduction of attributes other than basis occurs after the determination of tax for the year of discharge.

• Basis reduction occurs for assets held on the first day of the succeeding taxable year.

38

Consolidated § 108 -- § 1.1502-28

• Ordering rules with three key components: – Debtor First: Reduce attributes of the debtor – Look Through: Reduce attributes of debtor’s

subsidiaries to the extent of a reduction to the basis of a subsidiary’s stock

– Consolidated Attribute Reduction: Reduce attributes of other members of the group and available to debtor (i.e., basis of other members’ asset and SRLY- limited loss carryovers are not reduced)

• Results in separate member/single entity hybrid approach.

• Special Rules – Multiple debtor members with excluded COD income. – Elections under § 108(b)(5).

39

Debtor-First Rule

• Excluded COD income applied to reduce tax

attributes of the debtor

– reduction follows § 108(b)(2) order

• Attributes of the debtor include

– Portion of consolidated tax attributes of the debtor

– Debtor’s SRLY-limited tax attributes (or portion of such

of the debtor)

– Debtor’s basis in property, including stock in

subsidiaries (stock basis not reduced below zero)

40

Look-Through Rule

• Look-through rule triggered if debtor’s excluded

COD income is applied to reduce basis in stock

of a subsidiary held on the first day of the

following year (under § 108(b)(2) ordering).

• Subsidiary treated as realizing excluded COD

income to the extent of stock basis reduction.

• Debtor-first rules then apply to subsidiary.

• Repeat look-through if subsidiary’s deemed

excluded COD income is applied to reduce

basis in stock of a lower-tier subsidiary.

41

Consolidated Attribute Reduction

After applying the look-through rule, any excess excluded COD income is applied to reduce consolidated tax attributes of other members

Tax attributes of another member that arose in a separate return year are reduced if the debtor is a member of the SRLY subgroup with respect to the attribute or if no SRLY limitation applies (i.e., because of the Overlap Rule). In other words, another member’s attribute is reduced only if it would have been available to offset gross income of the debtor.

Attribute reduction follows § 108(b)(2) order and principles of § 1.1502-21(b)(1)

42

S3

S2 S1

P $20 Attributable CNOL

$50 Attributable CNOL

$30 SRLY NOL

$60 SRLY NOL $20 Attributable CNOL

P realizes $150 of excluded COD

ELA = $100 Basis = $100

Basis = $50

Example

Example--Results

• Under the debtor-first rule – • P’s $20 share of CNOL is reduced first. • P’s $100 basis in S2 stock is reduced, which causes S2 to be

treated as if it realized $100 of excluded COD. • Under the first application of the look-through rule --

• S2’s $50 CNOL and then its $50 basis in S3 stock is reduced. • S3 treated as realizing $50 of excluded COD

• Under the second application of the look-through rule – • S3’s $30 SRLY NOL is reduced • Note that the remaining $20 of deemed COD income has no

further consequences to S3. • Under the fan-out rule, the remaining $30 of unabsorbed COD

income reduces S1’s $20 CNOL. • S1’s $60 SRLY NOL is not affected (assuming that P and S1 are not

members of a SRLY subgroup).

• $10 of “black-hole” COD results.

43

Multiple members

• If in a taxable year, more than one member has excluded COD income, the debtor-first and look-through rules apply to each of those members before any consolidated attribute reduction occurs. § 1.1502-28(b)(1)(ii)

• If one of those members is a higher-tier member of the other, the debtor-first and look-through rules apply first to the higher-tier member before applying to the lower-tier member. § 1.1502-28(b)(1)(ii). – In applying those rules to the higher-tier member, the

limitation under § 1017(b)(2) on the reduction of asset bases is computed by assuming that the liabilities of the lower-tier member that gave rise to its excluded COD income were not discharged. Id.

44

Multiple members (cont’d)

• An allocation rule also applies if more than one member have excluded COD income that is not applied to its tax attributes.

• If the total of those “remaining” COD amounts exceeds the consolidated attributes available for reduction under § 1.1502-28(a)(4), a pro rata portion of each such member’s remaining COD amount is applied to reduce those consolidated attributes. § 1.1502-28(b)(1)(iii).

45

Multiple members (cont’d)

If more than one higher-tier member

reduces the basis of subsidiary stock in a

taxable year, the stock basis reductions are

applied to reduce the attributes of the

subsidiary under the look-through rule in

proportion to the excluded COD income

resulting from the basis reductions.

§ 1.1502-28(b)(1)(iv).

46

Multiple members (cont’d)

• A priority rule applies when subsidiary attributes may be reduced under the look-through rule to account for excluded COD income realized in different groups. The rule applies if the following three conditions are met:

– The subsidiary is a member of a group (the “first” group) on the last day of the taxable year in which a higher-tier member of that group realizes excluded COD income;

– On the following day, the subsidiary is a member of another group (the “second” group); and

– The basis of subsidiary stock is reduced under § 108, § 1017, and § 1.1502-28 to account for excluded COD income of both the higher-tier member of the first group and a higher-tier member of the second group.

§ 1.1502-28(b)(1)(v).

• If those conditions are met, the look-through rule applies first to account for the excluded COD income that results from the basis reduction in the subsidiary’s stock owned by the first group’s higher-tier member before it applies to account for the excluded COD income that results from the basis reduction in the subsidiary’s stock owned by the second group’s higher-tier member. Id.

47

Unified Loss Rules (“ULR”)

§ 1.1502-36

• Noneconomic tax losses on stock arising from uneconomic allocations under § 1.1502-32.

– Stock basis adjustments under § 1.1502-32 are pro rata, without a § 704(c) concept.

• “Son of mirrors” losses.

– § 1.1502-32 results in noneconomic basis increases that create a tax loss on a stock sale, though no economic loss.

• “Duplicated” losses.

– Two tax losses, one on stock and one on assets, though only one economic loss.

Categories of Losses

49

50

Basis Redetermination

• If a member (M) transfers a loss share of subsidiary (S) stock, all members’ bases in all shares of S stock are subject to redetermination. – Positive basis adjustments may be allocated from the transferred

loss shares and negative adjustments allocated to those shares.

– The effect of those reallocations is to reduce the group’s basis in the transferred loss shares (and increase its basis in other S shares).

• This basis-redetermination rule does not apply if, for example, the group disposes of entire interest in S in a taxable transaction (although group can elect to redetermine in this case). Thus, the rule rarely applies.

Record Keeping for Basis Redetermination

• Basis redetermination depends upon the knowledge of each share’s value and its investment adjustment history. But see § 1.1502-32(g), which requires the group to maintain permanent records to identify the amount and allocation of adjustments. This includes:

– When were shares issued (or deemed issued)

– Investment adjustment history for each year and within any year in which shares were issued (or deemed issued)

– May also require investment adjustment history while held in a prior group (for example, for lower-tier subsidiaries or when acquired in a transferred basis transaction)

• In practice, groups may not monitor annually, particularly given exception for sale of all shares of stock

51

52

• Rule: If a transferred S share is a loss share after the application of the basis redetermination rule, M’s basis in the share is reduced, but not below value, by the lesser of: – The share’s net positive adjustment, and

– The share’s disconformity amount

• Net positive adjustment (NPA). The sum of all investment adjustments (computed without regard to distributions) that are reflected in the basis of the share. This amount cannot be less than zero.

• Disconformity amount. The excess, if any, of M’s basis in the share over the share’s allocable portion of S’s “net inside attribute amount”.

Basis Reduction

53

Basis Reduction (cont’d)

• The “net inside attribute amount” equals: – the sum of S’s

• money,

• basis in assets other than money,

• net operating and capital loss carryovers attributable to S (without

regard to whether they are waived by the purchaser), and

• deferred deductions,

– minus S’s liabilities.

• The net inside attribute amount

– is determined immediately before the transfer, taking into

account all other rules of law (e.g., § 1.1502-32), and

– does not include S’s credits, if any.

• Facts: The X consolidated group acquires T stock from another consolidated group. When acquired, T owns all S stock with a $100 basis and FMV, S’s asset has a $60 basis and $100 FMV, and S has $40 of NPA. S’s asset declines in value, and T sells the S stock for $60 to an unrelated buyer.

• Basis Reduction: T’s $40 loss is disallowed because the disconformity amount and NPA both equal $40:

– Disconformity amount: $40 -- excess of T ’s $100 basis in the S stock, over S’s $60 net inside attributes (its asset basis)

– NPA: $40 (accrued before the X group acquired the T stock but reflected in T’s basis in its S stock)-- no positive or negative –32 adjustments

• Buyer Beware: Pre-acquisition history may affect post-acquisition loss.

T

S

AB $60

FMV $100

AB $100

FMV $100

T

S

T

S

AB $100

FMV $60

AB $100

FMV $100 $60

AB $60

FMV $100 $60

AB $60

FMV $60

Inheriting a Net Positive Adjustment

Buyer

54

§ 1.1502-36(c): Buyer Beware

• Suppose Buyer buys a member (T) of a consolidated group. T might or might not be the common parent. T has a subsidiary S.

• Suppose Buyer sells the T stock at a loss. The loss will be disallowed to the extent of the lesser of (1) Buyer’s NPA in the T stock, or (2) Buyer’s disconformity amount in T, which depends in part on T’s prior NPA in the S stock.

• Alternatively, suppose T sells the S stock at a loss. The loss will be disallowed to the extent of the lesser of (1) T’s NPA in the S stock, including adjustments attributable to periods before the Buyer’s acquisition, and (2) T’s disconformity amount in S.

• Thus, in either case, for Buyer to apply the rules, Buyer must know not only the stock and asset basis that exists at each level on the purchase date, but also the history of all NPAs in the stock of all direct and indirect subsidiaries of T.

– If Buyer acquired the T stock in a reorganization such as a “B” reorganization, and T was a subsidiary in another group, the history of NPA’s in the T stock itself in the prior group would also be relevant to Buyer.

55

56

• If a transferred share is a loss share after the application of the basis reduction rule, S’s attributes are reduced by S’s attribute reduction amount, which is the lesser of:

– Net stock loss--the excess, if any, of members’ aggregate bases in transferred S shares over the aggregate value of those shares.

– S’s aggregate inside loss--the excess, if any, of S’s net inside attributes (inside asset basis plus losses minus liabilities) over the value of all outstanding shares of S stock.

• Attribute reduction rule does NOT apply if the attribute reduction amount is less than 5% of the value of the shares transferred. – However, the group may elect to apply the rule, e.g. in order to

reattribute S’s losses.

Attribute Reduction

57

Application of Attribute Reduction Amount: The

Basics

• S’s attribute reduction amount is applied:

– First, to reduce recognized losses:

• >> Capital loss carryovers;

• >> Net operating loss carryovers; and

• >> Deferred deductions.

– Then, to reduce asset basis.

• The selling group may specify the losses to which the

attribute reduction amount (ARA) is applied. To the

extent the group doesn’t specify, they are reduced in the

following order:

– Capital loss carryovers (oldest to newest);

– Net operating loss carryovers (oldest to newest);

– Deferred deductions (proportionately).

58

§ 1.1502-36(d)(6) Election

• Group can avoid or reduce attribute reduction by electing to reduce members’ bases in transferred loss shares, reattribute S’s attributes to P (but only if S becomes a non-member), or both. – Can specify amount elected (or not elected).

– Can only reattribute up to ARA. No effect given to election for any amount in excess of ARA. However, P can make a protective election to reduce basis or reattribute attributes.

– Can reattribute § 382 limitation to which reattributed losses are subject.

– Stock basis reduction is deemed elected if the stock loss would be permanently disallowed.

• P can specify the losses to be reattributed; otherwise, losses are reattributed in the manner in which they would have been reduced under the default rule

• The election is made by a statement on or with the group’s return for the taxable year of the transfer. Statement by S is not required.

• In effect, the parties can convert what would otherwise be a current capital loss for the seller, or an NOL carryover subject to § 382 for the buyer, to an NOL carryover not limited by § 382 for the seller.

59

• Facts: M contributes $10 to S, and S borrows $90. S generates a $40 consolidated NOL carryover. S’s creditors acquire the S stock and M takes a worthless stock deduction.

• Basis Reduction: M’s $10 loss is allowed because $0 is the lesser of:

– Disconformity amount: $0 -- excess of M ’s $10 basis in the S stock, over S’s $10 net inside attributes ($60 cash and $40 NOLs minus $90 liabilities)

– NPA: $0 – no positive or negative investment adjustments

• Loss Duplication Result: M’s $10 loss is allowed, but S must reduce its NOL from $40 to $30 to prevent duplication. The group may elect to reduce M’s stock basis and retain the full $40 NOL in S or it can elect to reattribute $10 of the NOL to P.

M

S

Cash $100

M

S

M

S

AB $10

FMV $0

AB $10

FMV $10 $0

Loss Duplication With NOLs

Cash $60

NOL $40

Cash $60

NOL $40

Liabilities $90

Liabilities $0

Lenders

$90 $10

Creditors

Buyer Concerns Arising from Attribute Reduction

• Attribute reduction might arise any time the purchase price of S stock is less than the total net attributes of S, and the selling group has a loss on the S stock. A potential buyer of S will generally want P to elect to reduce stock basis instead of acquiring S with reduced attributes.

• The attribute reduction amount may not be known at closing

– S’s attributes may be subject to audit adjustment.

– Purchase price may be subject to adjustment.

– Buyer normally would not know or care about the selling group’s stock basis, or whether the selling group has a tax loss on the sale, and would want to be protected regardless of that basis.

• P can make a “protective election” to reduce stock basis at the time of sale in order to prevent any future attribute reduction to the buyer, even though the amount of the potential attribute reduction may not be known at that time.

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