Tax planning for disposition of worthless subsidiaries.
* If a consolidated group disposes of subsidiary stock, all or part of any recognized loss may be disallowed, determined under a formula contained in Regs. Sec. 1.1502-20(c). The factors taken into account for this determination include "losses attributable to the subsidiary and carried to the subsidiary's first taxable year following the disposition" (Regs. Sec. 1.1502-20(c) (2) (vi) (A) (2)).
Applying this formula to the disposition of a subsidiary with NOL or capital loss carryforwards often will result in loss disallowance. The consolidated group may be permitted to reattribute all or a portion of such losses--including losses subject to the separate return limitation year (SRLY) rules in Regs. Sec. 1.1502-21(c)--to the common parent except to the extent the subsidiary and any higher-tier subsidiaries are insolvent (i.e., total liabilities exceed the fair market value of assets, disregarding any debt owed to higher-tier group members); see Regs. Sec. 1.1502-20(g). Because of the insolvency restriction, reattribution of losses of worthless subsidiaries may be impossible. However, to the extent NOLs may be reattributed, what otherwise would be a capital loss on disposition in effect can be converted to NOLs.
* If, on the other hand, an insolvent subsidiary with NOL or capital loss carryforwards is dissolved (which will be a taxable transaction due to the insolvency) with its parent claiming a worthless stock deduction, application of the loss disallowance rule produces different results. Because the subsidiary will not carry any losses to a separate return year, losses attributable to the subsidiary will not be taken into account under the loss disallowance rule in determining the extent to which the worthless stock deduction will be disallowed. (If certain ownership and income tests are satisfied, the tax character of the allowed loss may be ordinary as opposed to capital; see Sec. 165(g) (3).)
Example: P is the common parent of a consolidated group that includes S. S was formed by P, and P's basis in S stock is $500. S's basis in its assets is zero. No extraordinary gain dispositions or positive stock basis adjustments (as defined in Regs. Sec. 1.1502-20(c) (1) (i) and (ii)) have occurred since P acquired S. The P group has a consolidated NOL, $400 of which is attributable to S. S does not meet the requirements necessary for P to characterize a worthless security deduction as ordinary. During 1996, an event occurred that established that S became worthless during the year and, as of the end of the year, S is insolvent (due to debt owed to P).
If P dissolves S, the dissolution would not be a tax-free liquidation under Sec. 332, because there would be no liquidating distribution to P as its shareholder; see, e.g., Regs. Sec. 1.332-2(b). P would be entitled to a worthless stock deduction for its $500 investment in S. Because S's NOL would not carry over to P (under Sec. 381), none of the $500 loss would be disallowed. Thus, P would be entitled to a $500 capital loss.
If P sells S to an unrelated buyer (X) for $10, P would recognize a $490 capital loss, $390 of which would be disallowed under Regs. Sec. 1.1502-20. However, with X's cooperation, P can elect under Regs. Sec. 1.1502-20(g) to retain $390 of the NOL attributable to S. Therefore, P would have a $100 capital loss and a $390 NOL carryover. Thus, although P's total loss is the same (net of the $10 sale price), by selling S and reattributing its NOL, P in effect has converted $390 of capital loss into a more useful, ordinary loss.
Note that had the facts of the example been different--e.g., if S's activities met the requirements under Sec. 165(g) (3) for ordinary loss treatment and S had capital loss carryforwards instead of NOLs--a greater amount of ordinary loss availability might have resulted from a worthless stock deduction. Also, the loss carryforwards are refreshened (i.e., a new 15-year carryforward period is created) when a worthless stock deduction is taken under Sec. 165(g) (3).
Another factor that should be considered in weighing the alternatives is the interaction of the loss disallowance rule and the election to "waive" loss carryforwards of an acquired subsidiary pursuant to Regs. Sec. 1.1502-32(b) (4). In the example, X may decide to waive irrevocably S's NOL carryforwards in order to avoid a negative stock basis adjustment under Regs. Sec. 1.1502-32(b) (3) (iii) if the NOLs subsequently expire. In many cases, the amount of the loss that can be expected to expire can be determined with reasonable accuracy (for example, when the loss will be subject to a relatively low Sec. 382 limitation after the acquisition).
If X does waive all or a part of S's NOL carryforward, the waiver would affect P's loss disallowance calculation, since the waived loss will not be "carried to the subsidiary's first taxable year following the disposition." The waiver apparently would result in P's capital loss on the stock sale not being disallowed, along with P's inability to retain S's NOL carryforward. Although in the example this may be detrimental to P because its loss will be capital, in certain situations the difference may be irrelevant to P. In fact, if S's NOL carryforward had been subject to limitations under Sec. 382 or the SRLY rules within the P group, P might prefer the capital loss alternative. Given the Sec. 382 and SRLY limitations on the use of S's loss after acquisition by X, it is advisable for P and X to consider these issues jointly to achieve the best overall result for both groups.
Note: Disposition of a worthless subsidiary involves a range of complicated tax and other issues arising in a variety of fact patterns. This discussion in intended to illuminate just one small piece of a big tax puzzle.
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|Author:||Boyer, Mark W.|
|Publication:||The Tax Adviser|
|Date:||Jul 1, 1996|
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