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Government finally tells taxpayers that they can't bump and strip.

On Mar. 9, 1993, final regulations were issued addressing certain transactions between members of a consolidated group known as the "bump and strip" technique. Regs. Secs. 1.1502-13(o) and 1.1502-14(g) basically retain the rules of Temp. Regs. Secs. 1. 1502-13T(o) and 1.1502-14T(c). However, a change was made for distributions two years after disaffiliation. In general, if a shareholder becomes legally entitled to a distribution at least two years after leaving the consolidated group, the distribution will not trigger deferred gain under the special bump and strip rules.

The temporary and final regulations were promulgated to eliminate a basis step-up with respect to stock of a subsidiary in a consolidated group. The Service believes the basis step-up is both artificial and abusive; hence, the effective date for a portion of the regulations is retroactive.

The final regulations are best described by examples. For the following examples, assume that corporations P, S1, S2 and S3 file a consolidated return on a calendar-year basis. P owns all of the outstanding stock of S1 and S2. S1 owns all 100 shares of the outstanding stock of S3. The S3 shares have an adjusted basis of $1,000 and a value of $ 1 0, 000.

Example 1: Intercompany sale of stock followed by (1) distribution of cash and (2) deconsolidation: trigger of hypothetical excess loss account (ELA) (i) The bump: S1 sells all 100 shares of S3 stock to S2 for $10,000 and recognizes $9,000 of gain (which is deferred). Sec. 304 does not apply pursuant to Regs. Sec. 1.1502-80(b). S2 takes a $10,000 basis in the S3 stock under Regs. Sec. 1. 1502-3 1 (a). (ii) The strip: S3 borrows $5,000 in 1992 and distributes the $5,000 to S2 in the same year. S3 has no current earnings and profits (E&P), and the distribution reduces S2's basis in the S3 stock from $10,000 to $5,000. (iii) S3 has no current E&P in 1993. On Dec. 31, 1993, S3 issues 100 shares (50%) of its stock to X, an unrelated party. Since S2 now owns less than 80% of S3, S3 ceases to be a member of the group and an ELA disposition event occurs under Regs. Sec. 1.1502-19(b)(2)(i). Note that none of the deferred gain would be triggered under Regs. Sec. 1.1502-13(f)(1)(i), since X acquires newly issued stock (the S3 stock to which the deferred gain is attached does not leave the consolidated group). Also, none of the deferred gain would be triggered under Regs. Sec. 1.1502-13(f)(1)(iii), since neither the selling member (S1) nor the owning member (S2) ceases to be a member of the consolidated group. (iv) If no bump had occurred, S1 would still own the S3 stock and S1 would have an ELA with respect to the S3 stock of $4,000 ($1,000 basis -- $5,000 distribution) immediately before deconsolidation. New Regs. Sec. 1.1502-13(o) therefore requires the "hypothetical" ELA of $4,000 to be triggered. Hence, $4,000 of the deferred gain is triggered, leaving $5,000 of deferred gain. Note that none of the deferred gain would otherwise be triggered under Regs. Sec. 1.1502-13(f)(1). (v) During 1994, S2 sells its 100 shares of S3 stock to X for $6,000. S2 recognizes gain of $1,000 on the sale. Furthermore, the remaining $5,000 of deferred gain on the 100 shares is triggered under Regs. Sec. 1.1502-13(f)(1)(i) since the property (S3 stock) is disposed outside the group.

Example 2: Intercompany distribution of stock followed by distribution of cash and deconsolidation: trigger of hypothetical ELA (i) Same as Example 1, except instead of S1 selling S3 to S2, S1 distributes S3 stock to P, resulting in a $9,000 gain to S3 under Sec. 311(b). The entire gain is deferred under Temp. Regs. Sec. 1.1502-14T(a). (ii) The tax result is the same as in Example 1 pursuant to new Regs. Sec. 1.1502-14(g).

Example 3: Distribution of cash followed by (1) intercompany distribution of stock and (2) deconsolidation: trigger of hypothetical ELA (i) The facts are the same as Example 2, except that the "strip" occurs before the "bump." Therefore, before the distribution of S3 stock to P, S1 has an ELA of $4,000 ($1,000 basis -- $5,000 distribution) in S3 stock. The results are the same as in Example 2. (ii) This result seems contrary to Regs. Secs. 1.1502-19(d)(1) and 1.1502-31(a), and Letter Ruling 8917077, in which the ELA was inherited by P. The preamble states that this regulation is consistent with the bump and strip rule despite the reordering of steps. The Treasury and the IRS intend to revise other parts of the consolidated return regulations consistent with this example.

Example 4: Intercompany sale of stock followed by (1) deconsolidation and (2) distribution of cash: hypothetical Sec. 301(c)(3) gain (i) The bump: S1 sells all 100 shares of S3 stock to S2 for $10,000 and recognizes $9,000 of gain, which is deferred. Sec. 304 does not apply pursuant to Regs. Sec. 1.1502-80(b). S2 takes a $10,000 basis in the S3 stock under Regs. Sec. 1.1502-31(a). (ii) S3 has no current E&P in 1992. On Dec. 31, 1992, S3 issues 100 shares (50%) of its stock to X, an unrelated party. Since S2 now owns less than 80% of S3, S3 ceases to be a member of the group. Note that none of the deferred gain is triggered under Regs. Sec. 1.1502-13(f)(1). (iii) The strip: S3 borrows $10,000 in 1993 and distributes $5,000 to S2 and $5,000 to X in the same year. S3 has no current E&P, and the distribution reduces S2's basis in the S3 stock from $10,000 to $5,000 under Sec. 301(c)(2). (iv) If no bump occurred, S1 would still own the S3 stock and S1 would receive a distribution under Sec. 301(c)(3) of $4,000 ($1,000 -- $5,000 distribution) resulting in capital gain. New Regs. Sec. 1.1502-13(o) therefore requires the "hypothetical" Sec. 301(c)(3) gain of $4,000 to be recognized. Hence, $4,000 of the actual deferred gain (as a result of the bump) is triggered, leaving $5,000 of deferred gain. Note that none of the deferred gain would otherwise be triggered under Regs. Sec. 1. 1502-13(f)(1). (v) If S2 does not become legally entitled (e.g., own stock on the record date) to the distribution until at least two years after the disposition event (as defined under Regs. Sec. 1.1502-19(b)(2)), no deferred gain would be recognized as a result of the cash distribution by S3 to S2. This two-year rule is a change from the temporary regulations.

Example 5: Intercompany distribution of stock followed by deconsolidation and distribution of cash: hypothetical Sec. 301(c)(3) gain (i) Same as Example 4, except instead of S1 selling S3 to S2, S1 distributes S3 stock to P, resulting in a $9,000 gain to S3 under Sec. 311(b). The entire gain is deferred under Temp. Regs. Sec. 1.1502-14T(a). (ii) The tax result is the same as in Example 4 pursuant to new Regs. Sec. 1. 1502-14(g).

Effective dates

Regs. Sec. 1.1502-13(o) (on intercompany sales of stock) applies to acquisitions of stock of a subsidiary in an intercompany transaction occurring after July 23, 1991.

Regs. Sec. 1.1502-14(g) (on intercompany distributions of subsidiary stock) applies to dispositions of subsidiary stock in tax years for which the due date (without extensions) of the return is after Mar. 14, 1990. However, a group may elect to apply the temporary regulations to postdisposition distributions to which a member becomes entitled before Mar. 9, 1993. Also, if gain is deferred on a distribution of subsidiary stock before 1989, and if the disposition of the stock occurs before Mar. 9, 1990, neither the temporary nor the final regulations apply.
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Author:Rainey, Steve
Publication:The Tax Adviser
Date:Jun 1, 1993
Words:1367
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