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Proposed consolidated regulations pose trap for unwary.

The proposed consolidated return basis adjustment regulations, published in the Federal Register on Nov. 12, 1993, substantially revise the rules for computing the basis of stock in lower-tier subsidiaries owned by consolidated group members.

Although these provisions are generally more sound than the current regulations, a serious problem exists when a consolidated group member purchases the stock of a loss company. Prop. Regs. Sec. 1.1502-32(b)(4)(iii) would in effect provide for a negative basis adjustment on the expiration of a subsidiary's net operating loss (NOL) carryover.

Example: P purchased the stock of S for $1,000,000. At the time of acquisition, S had a $10,000,000 NOL carryforward. On expiration of such carryforward, P has to reduce its basis in the S stock by $10,000,000, leaving P with a $9,000,000 excess loss account, which could then be triggered into P's income.

Prop. Regs. Sec. 1.1502-32(b)(4)(iii) apparently relies on two generally erroneous assumptions: (1) P's basis in S reflects a payment for the NOLs equal to $1 for each $1 of NOL; and (2) it is always possible for the full amount of S's NOLs to be absorbed. The first assumption is counter to economic reality, and the second ignores the operation of Sec. 382, as well as practical considerations.

The AICPA Tax Division has protested this provision and has suggested that, if there must be a basis reduction of any kind, such reduction be limited to the tax benefit P could derive from the use of S's loss, taking into account Sec. 382. In addition, the Tax Division proposed that an acquiring common parent of a consolidated group be allowed to elect to waive all or any part of a target's NOL carryover on the first consolidated return in which the target participates. Under such circumstances, no basis reduction to the target's stock would result.

The proposed regulations, if not amended, will become effective for basis determinations made on or after the date the regulations are finalized. Accordingly, when stock of a subsidiary is purchased before the effective date, this provision can have retroactive effect. In any event, consolidated groups considering acquisition of a target loss corporation should consider the potential impact of these proposed regulations in negotiating for the purchase of such company.
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Author:Rosen, Robert M.
Publication:The Tax Adviser
Date:Jan 1, 1994
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