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IRS issues proposed anti-loss-duplication consolidated regs.

The Service issued proposed regulations (REG-131478-02) based on the principle that a consolidated group is not entitled to more than one tax benefit from a single economic loss. The IRS and Treasury articulated this anti-loss-duplication objective in Notice 2002-18.

The proposed rules cover at least two types of transactions. In the first, a consolidated group absorbs a subsidiary member's (S's) inside loss (e.g., a loss carryforward, deferred deduction or loss inherent asset), and a group member then recognizes a loss on an S stock disposition that duplicates the inside loss. In the second, (1) a group member recognizes a loss on an S stock disposition that duplicates the S inside loss, (2) S remains a group member and (3) the group subsequently recognizes the inside loss. The proposed regulations consist primarily of two rules--a basis-redetermination rule and a loss-suspension rule.

Basis-Redetermination Rule

This rule requires group members to redetermine S stock basis immediately before a disposition or deconsolidation of S stock, if basis exceeds value. The rule applies differently depending on whether S stays in the group after disposition or deconsolidation. If S remains, the rule requires all the members to aggregate their S stock bases. Basis is allocated first to group members' S preferred stock, in proportion to (but not in excess of) the shares' value on the transaction date. Any remaining basis is then allocated among all the group members' S common stock in the same proportion. The rule would reallocate past adjustments to reflect economic, positive investment adjustments.

If immediately after the transaction, S leaves the group, the basis-redetermination rule requires a reallocation of the group members' S stock bases. The basis subject to reallocation is the lesser of (1) the loss inherent in the disposed of (or deconsolidated) stock and (2) S's deduction and loss items taken into account in computing the basis adjustment of any S stock share (other than those disposed of while S was in the group).

Only items attributable to formerly unrecognized or unabsorbed items are included in the reallocation. The proposed regulations presume that all deduction and loss items are attributable to the recognition and absorption of a deduction or loss, reflected in the disposed of (or deconsolidated) shares' basis. However, they permit a consolidated group to establish that these items are not in fact considered and, thus, not reallocated to other shares.

If S leaves the group immediately after the disposition or deconsolidation, the basis in the disposed of (or deconsolidated) shares is reduced by the basis subject to reallocation. To the extent of the basis subject to reallocation, the basis of all the group members' S preferred stock held immediately after the transaction is then increased to equal--but not exceed--the value immediately before such transaction.

The basis-redetermination rule would not apply if the group disposes of all of the S stock in a single tax year, in one or more fully taxable transactions, or if the group were allowed a worthless stock deduction for such stock. In those cases, if a second tax benefit has been derived from an economic loss, it must be recaptured in the tax year obtained. The proposed regulations also provide a lookthrough rule that would apply the basis-redetermination rule to stock of any lower-tier subsidiary members on the disposition or deconsolidation of a higher-tier member's stock. The basis adjustments would be made to the higher-tier member's stock.

Loss-Suspension Rule

The loss-suspension rule disallows a stock loss if the economic loss that gave rise to the loss is later reflected in a consolidated return. Under the rule, if after applying the basis-redetermination rule, a group member recognizes a loss on an S stock disposition and S remains in the group immediately thereafter, the selling member's stock loss is suspended to the extent of the duplicated loss.

The proposed regulations adopt a definition of duplicated loss substantially identical to that in former Regs. Sec. 1.1502-20, except that other group members' securities are not excluded from the computation of S aggregate asset basis. The loss-suspension rule would also apply if S leaves the group after the transaction, but still owns stock of another remaining S.

The duplicated loss can be calculated as follows:

The sum of S's:

1. Aggregate asset basis (excluding intragroup stock);

2. Loss carryforwards (which are carried to the first S post-disposition tax year); and

3. Deductions recognized, but deferred, under another provision.

Less the sum of:

4. S'S stock value; and

5. S liabilities taken into account for tax purposes.

The proposed regulations also include a substitute-asset rule, in which a member's loss on an asset disposition other than S stock would be suspended if(1) the member's asset basis was determined by reference to the basis of an S, for which there was a duplicated loss, and (2) immediately after the transaction, S remained a group member.

The suspended loss is reduced and never allowed, because the S deductions and losses are taken into account in the consolidated return. The proposed regulations contain a rebuttable presumption that all deductions and losses are attributable first to the duplicated loss that gave rise to a suspended stock loss. If a taxpayer can establish that a deduction or loss was not part of the suspended loss, it will not be required to reduce that loss. Note: the IRS and Treasury specifically request comments on this exception.

Under the proposed regulations, if S leaves the group, any suspended loss remaining would be allowed (to the extent otherwise allowable) on the return filed for the tax year that includes the last day that S was a group member. Any remaining suspended stock loss is permitted when the group is allowed a worthless stock deduction for all of its S stock. The group can use a suspended loss recognized on an S disposition, if it files a statement of allowable loss with its consolidated return for the year the loss was allowed.

Other Proposed Changes

The loss-suspension rule applies only if there has been an S stock disposition and S remains in the group immediately thereafter. The proposed regulations also provide a basis-reduction rule, in which a member disposing of S stock on the day before S leaves the group (and if S does not have a separate-return year) can reduce S stock basis to the extent of S's consolidated net operating loss and net capital loss carryforwards, as if they were absorbed immediately before the transaction. If S stock is deconsolidated and the deconsolidation is to avoid the basis-redetermination rule before disposition of S loss stock, basis redetermination applies immediately before the deconsolidation.

The proposed regulations also provide other anti-avoidance rules aimed at transactions circumventing the basis-redetermination and loss-suspension rules. For example, if a group member contributes a built-in-loss asset to a partnership or to a corporation that is not a group member and that entity then contributes the asset to an S to avoid those rules, it must adjust basis to prevent the group from obtaining more than one tax benefit from a single economic loss.

Another anti-avoidance rule intends to prevent a group from using a reimported loss to offset income. This rule would apply if (1) a group recognizes an allowable loss on an S stock disposition that generates a duplicated loss, (2) as a result of that disposition (or another), S leaves the group and (3) within the 10-year period beginning on the date that S left, its loss is reimported to the group. The proposed regulations generally prohibit the use of a reimported deduction or loss item to offset group income.

Proposed Effective Date

The proposed regulations (other than the anti-avoidance rule for reimporting a loss) would apply to transactions occurring after March 6, 2002, if they occur during a tax year for which the original return is due after temporary or final regulations are published in the Federal Register. The anti-avoidance rule for reimporting a loss would apply to losses reimported as a result of an event that triggers the rules occurring on or after the date the proposed regulations are filed with the Federal Register, but only if the event occurs during a tax year for which the original return is due after the rules are published.

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Article Details
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Author:Kautter, David J.
Publication:The Tax Adviser
Date:Jan 1, 2003
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