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Waiving a target's loss carryforwards - a preservation of stock basis.

If a target corporation (T) is acquired by a member of a consolidated group (P) in a tax year beginning after 1994, and any portion of T's loss carryover expires unused, P's basis in its T stock is reduced by the amount of such expiration (Regs. Sec. 1.1502-32(b)(3)(iii)(A)). This downward stock basis adjustment in the T stock can be avoided or ameliorated through an election to waive all or a portion of T's loss carryover. The election, as described in Regs. Sec. 1.1502-32(b)(4), generally is made on the acquiring group's consolidated return for the year of T's acquisition. In certain situations, the tax consequences of failing to waive T's loss carryovers can be severe.

Example: On Jan. 1, 1997, P acquired all of T's stock for $100 in a qualified stock purchase under Sec. 338(d)(3). At the time of the acquisition, T had a net operating loss (NOL) carryover of $10,000, which was subject to a Sec. 382 limitation and the separate return limitation year rules, and was set to expire at the end of 1999. Due to limitations on the use of T's NOL, the entire NOL expires unused. Therefore, P must reduce its stock basis in T by the amount of the expired NOL, creating a 9,900 excess loss account with respect to P's T stock (disregarding other T activity). An election to waive T's NOL on the 1997 consolidated return would have prevented this downward-stock basis adjustment, thereby holding P's stock basis in T at $100.

If P is a subsidiary of Parent in a consolidated group, the downward adjustment to P's basis in T on expiration of T's loss carryover also results in a downward adjustment to Parent's basis in its P stock. Therefore, failure to waive T's loss carryovers can result in downward stock basis adjustments throughout the tiers of corporations in the corporate chain that holds T's stock.

If an election to waive T's loss carryforwards is made, its loss carryovers are treated as expiring for all Federal income tax purposes immediately before T becomes a member of the P consolidated group. If T is a member of another consolidated group immediately before its purchase by P, the expiration of its loss carryforwards is deemed to occur immediately after it ceases to be a member of the prior group (Regs. Sec. 1.1502-32(b)(4)(i)).

If T is purchased by P in a "qualifying cost basis transaction" (QCBT) and an election to waive T's loss carryovers is made, the noncapital, nondeductible expense resulting from the deemed loss expiration does not result in a stock basis adjustment. A QCBT is a purchase (in which basis is determined under Sec. 1012) of T stock by members of an acquiring consolidated group in a 12-month period satisfying the requirements of Sec. 1504(a)(2) (80% of vote and value) (Regs. Sec. 1.1502-32(b)(4)(ii)(A)). If T is acquired in a non-QCBT (e.g., a tax-free reorganization or an indirect acquisition of T by an acquisition of its parent), and an election to waive its loss carryforwards is made, the T stock owned by P group members immediately after T becomes a member is subject to a downward stock basis adjustment for the deemed loss expiration (Regs. Sec. 1.1502-32(b)(4)(ii)(B)). The downward stock basis adjustment is limited to the lesser of (i) the amount of T's waived loss carryforward or (ii) the amount necessary to cause Ps basis in its T stock to equal T's net inside asset basis. However, this downward adjustment generally is not reflected in the stock basis of higher-tier members of either the transferring or acquiring groups (Regs. Sec. 1.1502-32(b)(4)(iii)). In addition, although there may be a basis reduction in T stock, basis will not be reduced below net asset basis; there is no similar "floor" if, instead, the loss is simply permitted to expire.

If T becomes a member of the P group as a result of a higher-tier corporation becoming a member and an election to waive the loss carryovers of a lower-tier subsidiary is made, stock basis adjustments are required within the tiers of acquired corporations. Thus, if P acquires the stock of S, which owns T, and an election is made to waive T's loss carryovers, S must reduce its stock basis in T by the amount of the loss carryovers deemed to expire (subject to the floor of T's net asset basis). However, provided the acquisition of S was a QCBT, there is no additional adjustment to P's stock basis in S (Regs. Sec. 1.1502-32(b)(4)(ii)(C)).

In general, it is advisable to waive T's loss carryforwards in situations in which the use of T's loss carryforwards within the P group is doubtful. However, caution must be exercised in determining the amount of T's losses to be waived, because the election is irrevocable and precludes any future use of the waived losses. Thus, the availability of the waiver election places added pressure on the need for accurate valuations and projections in determining the usable portion of T's loss carryforwards in light of Sec. 382 and other limitations. Additionally, the regulations state that the election statement may specify either the amount of losses waived, or the amount not walved; when making the election, groups are also well-advised to consider the effect audit adjustments for prior years might have on the amount of T's losses available when it joins the acquiring group.

A planning point should be noted in transactions in which a waiver of T's loss carryforwards is contemplated. When T is being purchased from a consolidated group, and the group is recognizing a loss on the sale, a waiver of T's loss carryforwards can lessen the effect to the seller of the loss disallowance rules of Regs. Sec. 1.1502-20 (due to a reduction in the amount of duplicated loss that must be taken into account by the seller when calculating its allowed loss). If, for example, T's losses are subject to significant limitations within the seller's consolidated group, this approach may result in more, efficient loss utilization than reattribution of T's existing losses pursuant to Regs. Sec. 1.1502-20(g). Therefore, the waiver of T's loss carryforwards may be a point of negotiation in certain transactional settings.
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Author:Lohnes, Timothy J.
Publication:The Tax Adviser
Date:Jul 1, 1997
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