Tax News

CCH (cch.taxgroup.com) reports:

  The IRS has issued proposed regulations that offer guidance with respect to the recovery of stock basis in certain distributions and transactions to which Code Sec. 301 applies. The regulations also provide guidance regarding the determination of gain and the basis of stock or securities received in exchange for, or with respect to, stock or securities in certain transactions. The proposed regulations impact shareholders and security holders of corporations and are necessary to provide such shareholders and security holders with guidance regarding the allocation and recovery of basis on distributions of property.

Background

  The main purpose of these proposed regulations is to provide a single model for stock basis recovery by a shareholder that receives a constructive or actual distribution to which Code Sec. 301 applies and a single model for sale and exchange transactions to which Code Sec. 302(a) applies, including certain elements of a reorganization exchange. These proposed regulations define the scope of the exchange that must be analyzed under particular Code provisions, and provide a methodology for determining gain realized under
Code Sec. 356 and stock basis under Code Sec. 358.

  The regulations also respond to comments received by the IRS regarding the current regulations under Code Sec. 358 and include amendments to the regulations under Code Sec. 304 that import statutory amendments to that section.

Exchanges and Distributions to Which Code Secs. 301 and 302 Apply

  The proposed regulations are intended to be a comprehensive approach to stock basis recovery and stock basis identification in order to produce consistent results among economically similar transactions, regardless of the transaction type or the specific Code provision that results in the application of Code Sec. 301 or 302(a). The primary theme of the regulations is that a share of stock is the basic unit of property that can be disposed of and, accordingly, the results of a transaction should generally derive from the consideration received in respect of that share. To harmonize the tax treatment of economically similar transactions, these proposed regulations adopt a single model for Code Sec. 301 distributions (dividend equivalent transactions) and a single model for sale or exchange transactions to which Code Sec. 302(a) applies (non-dividend equivalent transactions), regardless of whether Code Sec. 301 or 302(a) applies directly or by reason of Code Sec. 302(d), 304 or 356.

Distributions

  Code Sec. 301 distributions . Consistent with the fundamental notion that a share of stock is the basic unit of property, the results of a Code Sec. 301 distribution should derive from the consideration received in respect of each share of stock. Thus, the proposed regulations treat a Code Sec. 301 distribution as received on a pro rata, share-by-share basis with respect to the class of stock upon which the distribution is made.

  Dividend equivalent redemptions . The proposed regulations apply the same basis recovery rules to both dividend equivalent redemptions and certain Code Sec. 304 transactions. Accordingly, under the regulations, a dividend equivalent redemption results in a pro rata, share-by-share distribution to all shares of the "redeemed class" held by the redeemed shareholder immediately before the redemption. A constructive Code Sec. 301 distribution is conformed to an actual Code Sec. 301 distribution by identifying those shares with respect to which an actual Code Sec. 301 distribution would have been received, and by reducing the basis of only those shares. If less than all of the shares of a class of stock held by the taxpayer are redeemed, the proposed regulations provide that in a hypothetical recapitalization described in Code Sec. 368(a)(1)(E), the redeemed shareholder is deemed to exchange all its shares in the class, including the redeemed shares, for the actual number of shares held after the redemption transaction. Tracing rules preserve the basis of the shares exchanged in the recapitalization in the remaining shares of the redeemed class held by the shareholder. Thus, under the proposed regulations, a dividend equivalent redemption is generally treated in the same manner, and its results are the same as, a Code Sec. 301 distribution in which no shares were cancelled.

  Under current law, if all of the shares of a single class held by a shareholder are redeemed in a dividend equivalent redemption, any unrecovered basis in the redeemed shares is permitted to shift to other shares in certain circumstances. The proposed regulations do not permit the shifting of basis to other shares held (directly or by attribution) by the redeemed shareholder. Instead, the proposed regulations preserve the tax consequences of the unrecovered basis for the redeemed shareholder by treating the amount of the unrecovered basis as a deferred loss of the redeemed shareholder that can be accessed when certain conditions are satisfied, or alternatively, when all the shares of the issuing corporation (or its successor) become worthless within the meaning of Code Sec. 165(g).

  Dividend equivalent reorganization exchanges . If, pursuant to a reorganization, a shareholder receives qualifying property and boot in exchange for its target corporation stock, the tax consequences of the receipt of the boot under these proposed regulations will depend upon whether the reorganization exchange is dividend equivalent or not. To promote consistency between sale or exchange transactions, the proposed regulations provide that the overall reorganization exchange shall be taken into account in determining whether a particular exchange is dividend equivalent. Thus, a shareholder that exchanges a class of stock solely for boot and another class of stock solely for nonqualifying property shall consider the overall exchange (the exchange of the two classes of stock for boot and qualifying property) in determining whether each particular exchange is dividend equivalent. If it is determined that a reorganization exchange is dividend equivalent, because different classes of stock have distinct legal entitlements that are respected for federal income tax purposes, the proposed regulations provide that an exchange of a class of stock solely of boot is an exchange to which Code Sec. 302(d) applies.

  To ensure similar tax treatment of dividend equivalent reorganization exchanges and dividend equivalent redemptions, if the reorganization exchange is dividend equivalent the proposed regulations limit the ability of the exchanging shareholder to specify the terms of the exchange.

  Apportionment of interest and other expenses . Under the proposed regulations, the interest expense allocation and apportionment consequences of a dividend equivalent redemption are the same as an actual Code Sec. 301 distribution.

  Code Sec. 1059 . The proposed regulations do not affect the basis reduction provided for in Code Sec. 1059(e)(1)(A) if Code Sec. 1059(e)(1)(A)(iii) otherwise applies. Accordingly, to the extent of an extraordinary dividend, a redeeming shareholder would first reduce basis as prescribed by Code Sec. 1059(e)(1)(A). The proposed regulations would then apply to the extent the distribution is not a dividend within the meaning of Code Sec. 301(c)(1).

  Redemptions of stock held by partnerships, trusts and S corporations . The treatment of unrecovered basis as a deferred loss raises special issues where the redeemed shareholder is an S corporation, a partnership or a trust (a flow-through entity). The proposed regulations reserve with respect to the issues relating to redeemed shareholders that are flow-through entities pending further study and comment. The primary issue under study is whether an "outside" basis adjustment that reflects the deferred loss should occur at the time of the dividend equivalent redemption, or alternatively, when there is an inclusion date with respect to the deduction. The IRS has also requested comments with respect to deferred losses arising from unrecovered basis as presenting an opportunity to separate the deferred loss from the dividend income resulting from the redemption. The IRS also requests comments on the issue of when is appropriate to treat an owner of the flow-through entity as the redeemed shareholder, and when it is appropriate to treat the flow-through entity itself as the redeemed shareholder.

Redemptions Treated as a Sale or Exchange

  The proposed regulations do not limit the current law ability of a shareholder that owns shares of stock with different bases to decide whether to surrender for redemption high basis shares, low basis shares or any combination thereof. In addition, the proposed regulations affirm the ability of a shareholder to specify the terms of a reorganization exchange where the receipt of boot results in sale or exchange treatment. If it is determined that the reorganization exchange is not dividend equivalent, Code Sec. 302(a) will apply to the extent shares are exchanged solely for boot. A shareholder engaging in a reorganization exchange that is not dividend equivalent can specify the receipt solely of boot for a share, provided that the terms of the exchange are economically reasonable.

Extension of Tracing Principles to Certain Stock Transfers Not Reorganizations

  The proposed regulations broaden the application of the tracing principles under the Code Sec. 358 regulations to transfers of stock in Code Sec. 351 exchanges in which no liabilities are assumed. The proposed regulations also incorporate the deemed issuance and recapitalization approach of the current Code Sec. 358 regulations to section 351 exchanges to preserve basis if insufficient shares, or no shares at all, are actually issued in the exchange.

Request for Comments

  Finally, the proposed regulations request comments with respect to: the treatment of certain Code Sec. 306(c) redemptions treated as Code Sec. 301 distributions; nominal share deemed issued in all cash "D" reorganizations; and controlled corporations after a Code Sec. 355
pro rata split-up. Written or electronic comments, and a request for a public hearing, must be received by April 21, 2009.

Proposed Regulations, NPRM REG-143686-07, 2009FED ¶49,413

Other References:

 
Code Sec. 301

  CCH Reference - 2009FED ¶15,303G

 
Code Sec. 302

  CCH Reference - 2009FED ¶15,327G

  CCH Reference - 2009FED ¶15,329G

 
Code Sec. 304

  CCH Reference - 2009FED ¶15,376G

  CCH Reference - 2009FED ¶15,377BC

  CCH Reference - 2009FED ¶15,377CE

  CCH Reference - 2009FED ¶15,377G

 
Code Sec. 351

  CCH Reference - 2009FED ¶16,404BE

 
Code Sec. 354

  CCH Reference - 2009FED ¶16,432G

 
Code Sec. 355

  CCH Reference - 2009FED ¶16,462G

 
Code Sec. 356

  CCH Reference - 2009FED ¶16,491G

 
Code Sec. 358

  CCH Reference - 2009FED ¶16,551I

  CCH Reference - 2009FED ¶16,552AE

  CCH Reference - 2009FED ¶16,552LE

 
Code Sec. 368

  CCH Reference - 2009FED ¶16,751KG

 
Code Sec. 861

  CCH Reference - 2009FED ¶27,142G

 
Code Sec. 1002

  CCH Reference - 2009FED ¶29,224G

 
Code Sec. 1016

  CCH Reference - 2009FED ¶29,413G

 
Code Sec. 1374

  CCH Reference - 2009FED ¶32,202V

  Tax Research Consultant

  CCH Reference - TRC CCORP: 6,256.15

  CCH Reference - TRC CCORP: 21,100

  CCH Reference - TRC CCORP: 21,150

  CCH Reference - TRC CCORP: 21,250

  CCH Reference - TRC CCORP: 21,252.05

  CCH Reference - TRC CCORP: 39,256.10

  CCH Reference - TRC REORG: 30,152.15