Temp. regs. explain sec. 382 and built-in loss rules.

Temporary regulations were issued in 1996 (1996 TRs) effectively withdrawing 1991 proposed regulations (1991 PRs) on the use of NOLs by consolidated groups.(1) The 1996 TRs are substantially similar to the 1991 PRs and are generally effective for tax years (or testing dates) beginning after 1996. The areas most affected are (1) the SRLY rules, (2) the consolidated Sec. 382 rules and (3) the consolidated BIL rules.(2) A previous article(3) examined the SRLY rules and many of the planning opportunities available after the 1996 TRs. This article will analyze the consolidated Sec. 382 rules and the consolidated BIL rules. (Table 1 on page 441 defines the acronyms used in this article.)

Table 1: Acronymns Used in This Article

BIG = built-in gain
BIL = built-in loss
CNOL = consolidated net operating loss
CNOLCO = consolidated net operating loss carryover
CRY = consolidated return year
CTI = consolidated taxable income
FMV = fair market value
NOL = net operating loss
NOLCO = net operating loss carryover
NUBIG = net unrealized built-in gain
NUBIL = net unrealized built-in loss
PCM = parent change method
SM = supplemental method
SNOL = separate net operating loss
SRLY = separate return limitation year
SRY  = separate return year

Sec. 362 Overview

Overhauled in 1986, Sec. 382 embraces a "neutrality" principle that imposes an annual limit on the use of NOLs and other tax attributes following an ownership change of a loss corporation. Under this principle, the loss corporation's new owners should not be able to use more of its tax benefits than could its former owners; thus, under Sec. 382(b)(1), the losses and other benefits deemed available to the seller of the stock (and hence, available for use by the purchaser) are represented by the income that would be generated if the assets were sold for cash and the proceeds invested in long-term tax-exempt bonds.

According to Sec. 382(g), an ownership change occurs when one or more 5% shareholders of a loss corporation (defined by Sec. 382(k)(1) as a corporation entitled to use a NOL for the tax year in which the ownership change occurs) experience a change in ownership in the corporation's stock of more than 50% over the least amount they owned at any time during the testing period. The "testing period" normally begins, under Sec. 382(i)(1), three years before the date of the ownership change. In addition, Sec. 382(g)(4)(d) provides special rules for 50%-or-more shareholders who treat their loss corporation stock as becoming worthless during a tax year. If more than one ownership change occurs, a separate Sec. 382 limit must be computed for each.

Congress imposed additional restrictions under Sec. 382(1) in determining the loss corporation's value when computing the Sec. 382 limit. Generally, the value of the loss corporation's stock must be reduced by (1) capital contributions made during the two-year period ending on the ownership change date (Sec. 382(1)(1)(B)), (2) capital contributions made before the two-year period for the principal purpose of avoiding or increasing the Sec. 382 limit (Sec. 382(1)(1)(a)), (3) redemptions or other corporate contractions occurring in connection with the ownership change (Sec. 382(e)(2)) and (4) the net value of the nonbusiness assets on the change date, it at least one-third of the value of the corporation's total assets consists of nonbusiness assets immediately after the ownership change (Sec. 382(1)(4)). The Sec. 382 limit is reduced to zero under Sec. 382(c)(1) if the loss corporation fails to satisfy a continuity-of-business test for two years after the ownership change date.

In addition to the above restrictions, under Sec. 382(h)(3), if a loss corporation has a NUBIL on the change date that exceeds the lesser of $10 million or 15% of the FMV of the loss corporation's assets, the Sec. 382 limit applies to any BIL recognized by the loss corporation within five years after the change date as if it were a pre-change date NOL. Conversely, the Sec. 382 limit is increased by (1) any BIG recognized by the loss corporation within five years after the change date, if the loss corporation has a NUBIG on the change date that exceeds the $10 million/15% test and (2) any recognized deemed sale gain resulting from a Sec. 338(g) election made in connection with the ownership change.

While the foregoing is merely a brief summary of a very complex issue, it is intended to assist in the following discussion of the application of Sec. 382 to consolidated groups.

Example 1: On June 1, 1995, P corporation purchased 40% of the outstanding stock of S corporation. On Dec. 31, 1996, when S had an FMV of $1,000 and a $300 NOL, P purchased an additional 42% of S stock. The long-term tax-exempt rate for 1996 was 7%. Because a more-than-500/o change (40% + 42% -- 0%) in ownership took place in the three-year period ending Dec. 31, 1996, Sec. 382 applies to limit the amount of the $300 NOL that S can use in any given year to $70 ($1,000 FMV X 0.07). The $1,000 FMV must be reduced for any capital contributions made in anticipation of the Sec. 382 ownership change, including any contributions made within the past two years. Further, if S fails to continue its historic business in 1997 and 1998, its FMV will be deemed to be zero on Dec. 31, 1996, reducing the Sec. 382 limit to zero and rendering the NOL useless.

Consolidated Sec. 383 Rules

Historically, the consolidated return regulations (Regs. Sec. 1.1502) have generally applied a separate-entity theory in determining an affiliated group's taxable income, but employed a single-entity theory in examining the group as a whole. When the new Sec. 382 rules were enacted in 1986, no regulatory guidance was provided as to their application on a consolidated basis. As a practical matter, Sec. 382 could be applied on a separate-company basis, on a single-entity basis or on some hybrid basis (e.g., using an equity method). The 1991 PRs provided guidance on these issues, but confusion resulted from the failure to finalize those rules. The 1996 TRs effectively incorporate the 1991 PRs, effective for tax years (and testing dates) after 1996.

Both the 1991 PRs and the 1996 TRs offer a dual approach in their application of Sec. 382 to an affiliated group. Under each set of regulations, a loss group (or subgroup) is treated as a single entity (the parent change method (PCM)). As discussed below, to avert potential abuses of the PCM by having shareholders sell interests in subsidiaries, an equity approach (the supplemental method (SM)) also applies.

PCM

Whether a consolidated group has undergone an ownership change is determined using a single-entity approach; the group members are treated as divisions of a single taxpayer, with the common parent acting as the sole agent for each. Temp. Regs. Sec. 1.1502-92T(b) (1) (i) provides that, under the PCM, a loss group has an ownership change only if the common parent has undergone an ownership change under Sec. 382(g) and Temp. Regs. Sec. 1.382-2T. Thus, whether a loss group has an ownership change is not affected by transfers of ownership interests by group subsidiaries.

Example 2: P corporation files consolidated returns with its wholly owned subsidiary, L corporation, which has a NOL. In January 1997, 40% of P's stock is sold to an unrelated party; in July 1997, 20% of L's stock is sold to an unrelated party. Under the PCM, the sale of L's stock is ignored; because P's ownership changed by only 40%, there has been no Sec. 382 ownership change.

SM

Temp. Regs. Sec. 1.1502-92T(c)(2) applies the SM if a 5%-or-more shareholder of the common parent increases its percentage ownership in both the parent and a subsidiary within a three-year period; in such event, the group must use the PCM to determine whether an ownership change has occurred. However, any subsidiary stock received by a 5%-or-more shareholder is treated as common parent stock equal in value to the subsidiary stock received.

Example 3: A, an individual, owns 100% of P corporation's outstanding stock, with a $1,000 FMV P files consolidated returns with L, its wholly owned subsidiary, which has a NOL. P's L stock has an FMV of $600. Within a three-year period, B, an individual, purchases 49% of P's stock and 20% of L's stock. Because B, a 5%-or-more shareholder, increased ownership in both P (the common parent) and L (a subsidiary), the SM applies. B is treated as having acquired $610 of P stock ($490 [$1,000 X 0.49] of actual P stock + $120 [$600 X 0.20] of deemed P stock). P's outstanding stock is deemed valued at $1,120 ($1,000 actually issued + $120 deemed issued). Because B has increased his ownership value in P by 54.5% ($610/$1,120), an ownership change has occurred.

Applying Sec. 382 to a Consolidated Group

Sec. 382's single-entity approach is applied to determine whether an ownership change has occurred in a loss group (or subgroup). Temp. Regs. Sec. 1.1502-91T(c)(1) defines a loss group as any consolidated group that (1) is entitled to use a NOL that did not arise (and is not treated as arising) in a SRLY; (2) has a CNOL for a tax year in which a testing date of the common parent occurs (determined by treating the common parent as a loss corporation); or (3) has a NUBIL on the testing date.(4) (Loss subgroups are discussed below.)

Example 4: P corporation and L corporation file separate tax returns; each has a NOL arising in 1996 that is carried to 1997. P owns 60% of L's 100 outstanding shares. At the close of 1996, P buys L's remaining 40 shares; the corporations file a consolidated return for 1997. P and L become a loss group at the beginning of 1997, because the P-L group is entitled to use the NOLCO of P, the common parent, which did not arise (and is not treated by Temp. Regs. Sec. 1.1502-21T(c) as arising) in a SRLY.

Once a loss group has been identified and it is determined that an ownership change has occurred, the consolidated Sec. 382 limit is calculated by treating the loss group as a single entity. For any post-change year, the consolidated Sec. 382 limit equals the value of the loss group multiplied by the long-term tax-exempt rate. Under Temp. Regs. Sec. 1.1502-93T(a) (1) and (b) (1), the value of the loss group (or subgroup) is the value (immediately before the ownership change) of the stock of each member (including Sec. 1504(a)(4) preferred stock), other than stock owned (directly or indirectly) by another member, increased by any minority interests in subsidiary members.

Example 5: P corporation, L corporation and S corporation compose a loss group (P group). The FMV of P's outstanding common stock is $1,000, of L's outstanding common stock, $300 and of L's outstanding preferred stock (described in Sec. 1504(a)(4)), $40; S's outstanding common stock is worth $400. P owns 90% of L's common stock. A, an individual, owns 10% of L's common stock and all of its preferred stock. P owns 50%, L owns 30% and individual B owns 20% of S's common stock. If P undergoes an ownership change, the value of the P group is $1,150, calculated as follows: (1) the P

EXECUTIVE SUMMARY

* Basically, the 1996 TRs effectively incorporate the 1991 PRs, effective for tax years (and testing dates) after 1996.

* Adding to the complexity of the 1996 TRs is the fact that the SRLY, consolidated Sec. 382 and BIL rules each provide a different definition of "subgroup."

* The temporary, regulations allow a former group's common parent to elect to allocate some or all of the consolidated Sec. 382 limit to a departing member; if the common parent fails to make the election, the former member's Sec. 382 limit becomes zero, so that any losses apportioned to the departing member will be worthless. common stock, valued at $1,000, plus (2) the 10% of L common stock owned by A, valued at $30 ($300 x 0.10), plus (3) the L preferred stock owned by A, valued at $40, plus (4) the 20% of S common stock owned by B, valued at $80 ($400 x 0.20).

Temp. Regs. Sec. 1.1502-93T(b) (2) states that the value of the loss group may be further adjusted by Sec. 382 and the regulations thereunder. Thus, for example, the consolidated Sec. 382 limit would be zero if the loss group does not satisfy the continuity-of-business requirement for the two-year period beginning on the change date. Once again, this determination is made by looking at the loss group as a single entity.(5)

Corporations joining a Consolidated Group

Generally, when a corporation joins a consolidated group, both the SRLY and Sec. 382 rules apply to limit the use of the new member's NOLCOS; this overlap has led to suggestions that Treasury repeal the SRLY rules. However, there can be situations in which a corporation joins a consolidated group and the SRLY rules apply, but the Sec. 382 rules do not.

Example 6: P corporation is the common parent of the P-S group, which files a consolidated return. S corporation has owned 40% of the outstanding stock of T corporation for the past five years. S acquires an additional 40% of T's outstanding stock (for a total of 80%). T has a NOLCO from a prior year that will be subject to a SRLY limit, because it was created in an SRY. However, the NOLCO will not be subject to a Sec. 382 limit, because S's acquisition of the additional 40% of T's stock does not result in an ownership change.(6)

Subgroup concept: Temp. Regs. Sec. 1. 1502-91 T(d) generally defines a loss subgroup as two or more corporations that are continuously affiliated after ceasing to be members of one group; at least one of the corporations carries over losses from the first group to the second group. One concern about the subgroup concept is that the SRLY, consolidated Sec. 382 and BIL rules each define "subgroup" differently.

For example, for Sec. 382 purposes, Temp. Regs. Sec. 1.1502-91T(d) provides that a loss subgroup exists if (1) two or more corporations were affiliated with each other in another group, (2) these corporations bear a relationship to each other (described in Sec. 1504(a)(1)) through a loss subgroup parent immediately after they become members of the new group and (3) at least one of the members carries over a NOL that did not arise in a SRLY with respect to the former group. In the case of NOLCOs, Temp. Regs. Sec. 1.1502-21T(c)(2)(i) identifies a SRLY subgroup as composed of the member carrying over the loss (the loss member) and each other member that was a member of the former group at the same time as the loss member. A member remains a member of the SRLY subgroup until it ceases to be affiliated with the loss member.

Example 7: P corporation is the common parent of the P-S-T-U consolidated group (P group). P owns 100% of the stock of S corporation and T corporation; Towns 100% of the stock of U corporation. The P group has a CNOL, a portion of which is attributable to each of the member corporations. Z corporation simultaneously acquires all of the S stock for $1,000 and all of the T stock for $600. The long-term tax-exempt rate is 6%. The new consolidated group, Z-S-T-U (Z group), files a consolidated return with the following income and loss amounts:

                     CTI

   Z                $100
   S                  50
   T                  50
   U                 (20)

   Total            $180

The acquisition of S and T constitutes ownership changes; T and U comprise a Sec. 382 loss subgroup. However, S is not included in that subgroup, because it does not bear a relationship described in Sec. 1504(a)(1) to either T or U immediately after becoming a Z group member; thus, two Sec. 382 limits must be computed: (1) $60 ($1,000 x 0.06) for the T-U subgroup and (2) $36 ($600 x 0.06) for S.

S- T- U comprise a SRLY subgroup, as they have been continuously affiliated; that subgroup is subject to a single SRLY limit of $80 (S's $50 + T's $50 + Us $(20)). When one provision (Sec. 382) results in multiple limits and another (SRLY rules) provides a single overall limit, it is not clear how the limits should be integrated. Because the $80 SRLY limit is smaller than the sum of the two Sec. 382 limits, $96 $60 + $36), $80 should be the maximum NOLCO than can be used by the Z group in its first CRY. It seems logical that principles similar to those of Temp. Regs. Sec. 1.1502-21T(b)(1) (i.e., pro rata allocation) should be applied to determine which loss corporation's NOLs are included in the $80 used in Z's first CRY. If such principles apply, $50 ($60/$96 x $80) of the losses absorbed are attributable to T-U; $30 ($36/$96 x $80) of the losses absorbed are attributable to S. For the next CRY, T-U and S will have unused Sec. 382 limits of $10 ($60 -- $50) and $6 ($36 -- $30), respectively.

Corporations Leaving a Consolidated Group

When a corporation (or a subgroup) leaves a consolidated group currently subject to a consolidated Sec. 382 limit, several traps for the unwary arise under the temporary regulations. Tax professionals must be aware of these rules to avoid disadvantageous consequences on the sale of a group subsidiary.

When a corporation leaves a consolidated group, Temp. Regs. Sec. 1.1502-21T(b)(2) requires that any CNOL be apportioned to each member that had an SNOL in the year in which the CNOL was created. When a member leaves the group, any losses apportioned to that member must be carried to that member's SRY. Even if the departing member will not be able to use the loss (due to the Sec. 382 and SRLY limits), the consolidated group cannot retain it.(7) Any losses apportioned to the departing member with usually be subject to a new Sec. 382 limit and the SRLY rules if it joins another consolidated group. In addition,temp. Regs. Sec. 1.1502-95T(b)(2)(i) provides that if the former group was already subject to a consolidated Sec. 382 limit, the departing member's losses continue to be subject to such limit. Temp. Regs. Sec. 1.1502-95T(c) allows the former group's common parent to elect to allocate some or all of the consolidated Sec. 382 limit to the departing member; if the common parent fails to make an association election,temp. Regs. Sec. 1.1502-95T(b)(2)(ii) provides that the former member's Sec. 382 limit becomes zero. Thus, in the absence of an allocation election, any losses apportioned to the departing member will be worthless.

According to Temp. Regs. Sec. 1.1502-95T(e), the allocation election must be filed by the common parent on a separate statement and attached to its consolidated return for the tax year in which the former member ceases to be a member of the group. The election must be signed by bodi the common parent and the former member; a copy of this statement must be delivered to the former member by the day the group files its tax return. A copy of the statement must be attached to the first return of the former member filed after the close of the departed group's CRY.

Example 8: P corporation is the common parent of the P-S-T consolidated group (P group). The P group has a CNOLCO subject to a $100 consolidated Sec. 382 limit; a portion of the CNOLCO is attributable to each P group member. T's stock is sold to the Z consolidated group, constituting an ownership change resulting in a $25 Sec. 382 limit. The amount of the CNOLCO apportioned to T will be subject to a SRLY limit and the $25 Sec. 382 limit; T's portion of the CNOLCO continues to be subject to the P group's consolidated Sec. 382 limit. P may elect to allocate some or all of the $100 consolidated Sec. 382 limit to T. Because T's NOLCO is already subject to a $25 Sec. 382 limit, nothing would be gained by allocating to T more than $25 of the P group's consolidated Sec. 382 limit. If no allocation election is made, however, none of the P group's consolidated Sec. 382 limit is deemed allocated to T, so that T's portion of the CNOLCO could not be used by the Z group. Thus, failure to understand the Temp. Regs. Sec. 1.1502-95T(c) allocation election can result in disastrous tax consequences.

Because the failure to allocate some or all of a consolidated Sec. 382 limit to a departing group member can create very undesirable results, tax advisers must be aware of the allocation issue; fortunately, a unction that results in the departure of a group member will usually be highly visible. A much more subtle situation occurs when a subsidiary leaves a loss subgroup, but does not leave the consolidated group. According to Temp. Regs. Sec. 1.1502-95T(d)(1)(ii), a corporation ceases to be a member of a loss subgroup on the first day it ceases to bear a Sec. 1504(a)(1) relationship to the loss subgroup parent. Thus, if a loss subgroup member ceases to be the loss subgroup parent's (direct or indirect) subsidiary, the common parent must allocate some or all of the subgroup's Sec. 382 limit to the departing member; otherwise, the consolidated group will no longer be able to use the departing member's portion of the subgroup's NOLS.

Example 9: P corporation acquires 100% of the stock of S corporation, which owns 100% of the stock of T corporation. S and T have filed consolidated return and have NOLCOS. P-S-T (the P group) files a consolidated return. S and T are a loss subgroup subject to a Sec. 382 limit. S distributes the T stock to P in a tax-free Sec. 355 transaction. T is still a P group member, but no longer bears a Sec. 1504(a) (1) relationship to S; thus, if P fails to elect to allocate the subgroup's Sec. 382 limit to T, any losses attributable to T cannot be used by the P group, because they are subject to a zero Sec. 382 limit.

The most troubling aspect of Temp. Regs. Sec. 1.1502-95T(d)(1)(ii) is that the repositioning of a subsidiary member within the consolidated group is a somewhat common transaction that may not involve close scrutiny of a subgroup's NOLs. Thus, tax professionals must be aware of this concern and carefully monitor any internal restructuring of a consolidated group.(8)

End of Separate Tracking of Losses

In general, the consolidated Sec. 382 temporary regulations limit pre-change losses or NUBILs of a member (or loss subgroup) undergoing an ownership change when it joins the consolidated group. However, sometimes, a change of ownership may not be occurring simultaneously (e.g., if the acquisition of 50% (or less) of the joining member's stock results in affiliation with the group); in such case, Temp. Regs. Sec. 1.1502-96T(a) alleviates the need to separately determine the occurrence of a future change in ownership of the acquired member, but allows the group to determine whether a change has occurred with respect to such member's pre-acquisition losses solely by reference to whether the loss group (i.e., the acquiring common parent) has experienced an ownership change.

Specifically, Temp. Regs. Sec. 1.1502-96T(a)(1) provides that if an acquired member has a SRJY NOL or a NUBIG or NUBIL when it becomes a member, and (1) a Sec. 382 ownership change of it (or its loss subgroup) occurs in connection with (or after) becoming a member, or (2) no Sec. 382 ownership change occurs with respect to the member (or loss subgroup) within five consecutive years following the day it becomes a member, there will be a Sec. 382 ownership change only if the loss group experiences a change. However, the prior acquisition of the loss member's stock may be considered in making this determination. Any prior losses of the member (or loss subgroup) not previously subject to Sec. 382 will thereafter be considered pre-change consolidated attributes subject to the loss group's Sec. 382 limit.

Example 10: P corporation, which owned 60% of the stock of L corporation for the past five years, bought the remaining 40% on Feb. 1, 1997; L did not have a Sec. 382 ownership change. If, on Feb. 1, 1998, there is a more-than-10% change in ownership with respect to P, L's pre-acquisition losses will be deemed pre-change consolidated attributes subject to the consolidated Sec. 382 limit.

Application of Sec. 382 to

Controlled Group Members

Sec. 382(m)(5) authorizes the Service to issue regulations to prevent the duplication of value in determining the Sec. 382 limit for controlled group members. Temp. Regs. Sec. 1.382-8T requires an adjustment that reduces the value of the loss corporation by the value of the stock of each component member of the controlled group that the loss corporation directly owns immediately after the ownership change. (10) Temp. Regs. Sec. 1.382-8T(b) generally requires these adjustments only when corporations are members of the same controlled group that includes the loss corporation both (1) in the year a pre-change loss arose and (2) on the date the loss corporation has an ownership change. For this purposes, a "controlled group" is defined by Sec. 382(m)(5) as having the same meaning as in Sec. 1563(a), but determined by substituting "50%" for "80%" each place the latter appears. Thus, a controlled group would include a parent-subsidiary group linked together by at least 50% stock ownership.

Example 11: A, an individual, owns all the stock of L corporation. L and individual B own 80% and 20%, respectively, of P corporation's stock; P and individual C own 75% md 25%, respectively, of L 1 corporation's stock. L and L1 each have NOLCOs that originated while they and P were members of the same controlled group. While they are still members of that group, A sells the L stock to individual D. Because each corporation is a component member of a controlled group, the value of P and L must be reduced in determining the Sec. 382 limit on the use of losses. The FMV of the L1 stock is $40, of the P stock, $100 and of the L stock, $200. For this purpose, P's FMV is reduced by the value of the L I stock it directly owns, to $70 ($100 - [$40 x 0.75]); L's FMV is reduced by the value of the P stock it directly owns, to $120 ($200 -- [$100 x 0.8]).

Temp. Regs. Sec. 1.382-8T(c)(2) permits an election to restor-e pr-eviously reduced value, by having one group member reduce its value and allowing another member to assume such value.(11)

Transition Rules

According to Temp. Regs. sec. 1.1502-99T(a), the consolidated Sec. 382 temporary regulations generally apply to testing dates after 1996.(12) For periods ending before 1997, a consolidated group can generally use one of three methods: (1) a method that does not materially differ from Temp. Regs. Secs. 1.1502-91T through -96T and -98T; (2) a reasonable application of the rules in Sec. 382 and the regulations thereunder applied to each member on a separate-entity basis; or (3) a method approved by the Service on application by the common parent.

A previous article(13) highlighted the planning opportunities provided by the SRLY transition rules.

While the tax planning opportunities under the Sec. 382 transition rules may not be as plentiful, certain situations will benefit from early application of such rules. Temp. Regs. Sec. 1.1502-99T(d) provides that a group may file an amended return in connection with a pre-1997 ownership change if: (1) files amended returns for the earliest tax year ending after 1986 in which it had an ownership change, (2) it files amended returns for all subsequent tax years for which returns have already been filed as of the date of the amended return, (3) the modification with respect to all members for all tax years ending in 1987 and thereafter complies with Temp. Regs. Secs. 1.1502-91T through -96T and -98T and (4) the amended returns permitted by the applicable statute of limitations were filed before Mar. 26,1997.

BIL Rules

The BIL rules ensure that consolidated groups do not circumvent the SRLY rules by (1) acquiring corporations with deductions or losses that have economically accrued in a SRLY and (2) recognizing the BIL after the corporation becomes a member of the consolidated group. In the absence of the BIL rules a corporation could offset, without limit, these recognized BILS against income of the other group members. To avoid this result, if a new group member recognizes BILS within a specified time period, the losses win be subject to the SRLY rules.

Most of the changes made to Regs. Sec. 1.1502-15A were part of a process to conform the BIL rules to the consolidated Sec. 382 rules. To accomplish this, the 10-year recognition period in Regs. Sec. 1.1502-15A(a)(4)(a) was shortened to five years to conform to Sec. 382(h)(7). In addition, the threshold requirement of Sec. 382(h)(3)(b) is now included in Temp. Regs. Sec. 1.1502-15T(b) (1) (i.e., the NUBIL is zero if it does not exceed the lesser of (1) 15% of the FMV of the acquired corporation's assets or (2) $10 million).(14)

Perhaps the most significant change is that the BIL rules are now applied on a subgroup basis. While this is logical, the BIL definition of a subgroup differs from the SRLY and Sec. 382 definitions of a subgroup. Temp. Regs. Sec. 1.1502-15T(c)(2) defines a subgroup for BIL purposes as composed of those members that have been continuously affiliated with each other during the 60-month period ending immediately before they became members of the group in which the loss is recognized. Apparently, the 60-month period was adopted to conform with the Sec. 382(h)(7) recognition period, and represents the period after which Sec. 382 (if applicable) would no longer separately identify built-in amounts.

Whether a subgroup has a NUBIL depends on the aggregate of the separately computed NUBIG or NUBIL of each subgroup member; the separate computations do not include any unrealized BIG or BIL on stock (including Sec. 1504(a)(4) stock) of another member. The threshold requirement of Sec. 382(h)(3)(b) applies on an aggregate, not a member-by-member, basis.(15)

Example 12: In Year 1, P corporation acquires all of the stock of S corporation. S is the common parent of the S-T group, which has filed consolidated returns for six years. When P acquires the S stock, S and T separately have the following:

Corporation   NUBIL/NUBIG    Consisting of

    S         $100 NUBIL      Asset 1: Basis $120, FMV $10
                              Asset 2: Basis $30, FMV $40

    T          $60 NUBIG      Asset 3: Basis $10, FMV $70

The acquisition of S constitutes an ownership change; S and T are a loss subgroup for Sec. 382 purposes. S and T are also a subgroup for BIL purposes, because they were continuously affiliated for the 60-month period ending inimediately before they became members of the P group; consequently, their NLJBIG and NUBIL are aggregated. The S-T subgroup has a $40 NUBIL; comprised of an $110 unrealized BIL on Asset 1, and the $10 and $60 unrealized BIGS on Assets 2 and 3, respectively. The S-T subgroup's $40 NUBIL exceeds the threshold requirement under Sec. 382(h)(3)(b) ($18, the lesser of $10 million or 15% of $120).

While the BIL rules have been modified largely to make them more consistent with the Sec. 382 rules, there is one significant difference -- for Sec. 382 purposes, the amount of BIL recognized cannot exceed the NUBIL existing at the time of the ownership change. If a BIL is recognized within the five-year recognition period, the SRLY limit applies to it, regardless of the NUBIL in existence when the corporation (or subgroup) joined the consolidated group.

Example 13: The facts are the same as in Example 12. In Year 3, S sells Asset 1 for $ 10. Because Asset 1 is sold within the five-year recognition period, the BIL rules apply. Sec. 382(h)(1)(b)(ii), which limits the amount of recognized BIL treated as a pre-change loss to the NUBIL, does not apply; consequently, the $110 unrealized loss in Asset 1 is treated as a recognized BIL subject to the SRLY limit. Only $40 of the recognized BIL is subject to the consolidated Sec. 382 limit.

A BIL is treated as a loss carryover arising in a SRLY in determining the SRLY limit on the BIL in the year recognized. A BIL is absorbed (to the extent permitted by the SRLY limit) in the year recognized before any loss (e.g., carryover or carryback) of the same character carried to that year. If the BIL is disallowed by the SRLY limit, it is treated as a loss sustained in that year that can be carried back or forward subject to the SRLY limit.

If a BIL is disallowed due to a reason other than the SRLY limit (e.g., the Sec. 382 limit), it nevertheless remains subject to the SRLY limit in any subsequent year to which it is carried. If the loss is allowed under both the SRLY and Sec. 382 limits, but the group has insufficient income to offset the loss, it contributes to the group's CNOL in the year recognized; it is carried forward or back to CRYS or Skys under the principles of Sec. 172 and Temp. Regs. Sec. 1.1502-21T(b), but is no longer subject to the SRLY limit.

Example 14: The facts are the same as in Example 13. The P group's income for Years 2 and 3 (without taking into account S's recognition of its unrealized BIL) is as follows:

Corporation     Year 2    Year 3    Total
P                $40       (10)      $30
S                 20        10        30
T                 10        10        20

CTI              $70       $10       $80

In Example 13, S recognizes a $1 10 BIL in Year 3. The cumulative income contributed by the S- T subgroup since becoming members of the P group is $50; this is the maximum amount that can be allowed in Year 3 under the SRLY limit. The other $60 of recognized BIL is treated as a NOL created in Year 3 that can be carried back or forward under Sec. 172, but is still subject to the SRLY limit. The $50 recognized BIL that satisfies the SRLY limit in Year 3 is further limited by the fact that, in that year, the P group has only $10 of CTI (determined without regard to the $110 recognized BIL). The $40 recognized BIL that cannot be used in Year 3 due to the CTI limit is treated as a CNOL that may be carried forward or back under Temp. Regs. Sec. 1.1502-21T(b) and absorbed under Temp. Regs. Sec. 1.1502-21T(a). The $40 CNOL, however, is not subject to the SRLY rules in those carryforward or carryback years.

Conclusion

The IRS has finally drawn a line in the sand, allowing taxpayers to proceed in using the NOLS and BILS of an affiliated group filing a consolidated group. Although this article examined the basic provisions of the consolidated Sec. 382 temporary regulations, as well as the BIL rules, it merely illuminated many of the issues that must be addressed in carrying out the rules' overall single-entity thrust. Hopefully, this article demonstrated that a number of exceptions and refinements exist to the general treatment of the affiliated group as a single entity. While these exceptions and refinements are an appropriate manifestation of tax policy concerning consolidated Sec. 382, the new rules require careful scrutiny in their application to affiliated groups filing consolidated returns.

(1) TD 8677 (6/26/96), IRB 1996-30, 7; TD 8678 (6/26/96), IRB 1996-31, 11; and TD 86799 (6/26/79), 1996-31, 4. TD 8678 added Temp. Regs. Sec. 1.1502-90T through -99T, effectively replacing Props. Regs. Sec. 1.1502-90 through -99 (CO-132-87, 1/29/91). This article deals exclusively with NOL carryforwards; however, the significance of the issues discussed herein have even broader application, because Sec. 383 and Temp. Regs. Sec. 1.383-1T provide that if an ownership change occurs with respect to a loss corporation, for any post-change year, Sec. 382 limits the capital gain or regular tax liability that may be offset by the loss corporation's pre-change capital losses and excess credits.

(2) Regs. Sec. 1.1502-15A(a)(2)(i) defines "built-in deductions" as deductions or losses that economically accrue in a SRLY, but are recognized in a CRY. For consistency with Sec. 382(h), Temp. Regs. Sec. 1.1502-15T(b) uses "built-in losses" rather than "built-in deductions." This article uses "built-in losses" (BILs).

(3) See Thompson, Stewart and Rosen, "SRLY Loss Temp. Regs. Offer Significant Planning Opportunities," 27 The Tax Adviser 738 (Dec. 1996).

(4) Temp. Regs. Sec. 1.1502-91T(c)(2) provides that Temp. Regs. Sec. 1.1502-96T(a) treats certain group members (or loss subgroups) with NOLCOs (or NUBIGs and NUBILs) as satisfying the definition of a loss group.

(5) Sec. 382(c)(1) and Temp. Regs. Sec. 1.1502-93T(d). In illustrating the application of this rule, the example in Temp. Regs. Sec. 1.1502-93T(d)(2) appears to indicate that a discontinuance of two-thirds (in value) of a historic business will not violate the continuity-of-business requirement if the other one-third (in value) of the business is continued.

(6) When both the SRLY and the Sec. 382 rules apply to limit the same NOLCO, unwarranted complexity results. The AICPA Tax Division has provided written comments to the Service and testified that application of. the SRLY rules should be limited to situations in which the member's NOLs are not otherwise limited by Sec. 382. However, until the Service limits the application of the SRLY rules, tax professionals must deal with the ensuing complexity.

(7) Regs. Sec- 1.1502-20(g) provides an exception that permits the common parent to make an irrevocable election on certain dispositions of subsidiary stock at a loss.

(8) The AICPA Tax Division, in both written and oral comments, has recommended that either the temporary regulations be modified to (1) continue to treat as members of the loss subgroup corporations that no longer bear a Sec. 1504(a)(1) relationship to the loss subgroup parent after separate tracking of the ownership of the loss subgroup parent has ended or (2) remove the requirement that the Temp. Regs. Sec. 1.1502-95T(c) election be made when members leave the loss subgroup but remain members of the consolidated group.

(9) TD 8679, note 1.

(10) Temp. Regs. Sec. 1.382-8T(a) and (c)(1). The temporary regulations are generally effective for ownership changes with respect to a controlled group loss after 1996, but contain transition rules for controlled group members that have had an ownership change for a pre-1997 loss;see Temp. Regs. Sec. 1.382-8T(j)(2)(i).

(11) See Temp. Regs. Sec. 1.382-8T(h).

(12) Temp. Pegs. Secs. 1.1502-91T through -96T and 1.1502-98T apply to any testing date after 1996. Temp. Regs. Secs. 1.1502-94T through -96T also apply on any date after 1996 on which a corporation becomes a group member or ceases to be a member of a loss group (or subgroup).

(13) See note 3.

(14) See Temp. Regs. Secs. 1.1502-15T(c)(3) and -91T(g).

(15) For the rules determining the NUBIGs or NUBILs in a subgroup, see Temp. Pegs. Secs. 1.1502-15T(c)(3) and -91T(c).