CO-49-88 Final

[Federal Register: June 22, 1994]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8546]
RIN 1545-AL58

Limitations on Corporate Net Operating Loss

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final income tax regulations providing
rules for allocating net operating loss or taxable income, and net
capital loss or gain, within the taxable year in which a loss
corporation has an ownership change under section 382 of the Internal
Revenue Code of 1986. These regulations permit the loss corporation to
elect to allocate these amounts between the period ending on the change
date and the period beginning on the day after the change date as if
its books were closed on the change date.

EFFECTIVE DATE: These regulations are effective June 22, 1994.
For dates of applicability of these regulations, see the EFFECTIVE
DATE paragraph in the SUPPLEMENTARY INFORMATION portion of the
preamble.

FOR FURTHER INFORMATION CONTACT: Roberta F. Mann of the Office of
Assistant Chief Counsel (Corporate), Office of Chief Counsel, IRS, 1111
Constitution Avenue, NW, Washington, DC 20224 (Attention:
CC:DOM:CORP:5) or telephone 202-622-7550 (not a toll- free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3504(h))
under control number 1545-1381. The estimated annual burden per
respondent is estimated to be 0.1 hour.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be directed to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP,
Washington, DC 20224, and to the Office of Management and Budget,
Attention: Desk Officer for the Department of the Treasury, Office of
Information and Regulatory Affairs, Washington, DC 20503.

Background

This document contains final regulations to be added to the Income
Tax Regulations (26 CFR part 1) under section 382 of the Internal
Revenue Code. The final regulations provide rules for the allocation of
net operating loss or taxable income and net capital loss or gain
within the taxable year in which a loss corporation has an ownership
change. Proposed regulations on this subject were set forth in a notice
of proposed rulemaking published in the Federal Register on November
19, 1992 (57 FR 54535). The IRS received public comments on the
proposed regulations. No public hearing was requested and none was
held. Having considered the comments submitted, the IRS and the
Treasury Department adopt the proposed regulations as revised by this
Treasury decision.

Explanation of Provisions

Following an ownership change, section 382 limits the amount of
post-change income that may be offset by a corporation's pre-change
loss. Sections 382(b)(3)(A) and (d)(1) require that, except as provided
in section 382(h)(5) (relating to certain built-in gains and losses)
and in regulations, taxable income or net operating loss must be
allocated ratably to each day in the change year for purposes of
applying the section 382 limitation. Under section 383, similar rules
apply with respect to pre-change capital losses and certain pre-change
credits.
The proposed regulations provide rules for allocation of net
operating loss or taxable income, and net capital loss or gain, within
the change year. The proposed regulations generally provide that a loss
corporation may allocate such items between the pre-change period and
the post-change period (1) by ratably allocating an equal portion to
each day in the change year, or (2) if it so elects, based on a closing
of its books as of the change date. The final regulations adopt the
proposed regulations with few changes. The most significant comments
and changes are described below.

A. Consistency Rules for Consolidated and Controlled Groups

The proposed regulations provide consistency rules for corporations
that are members of consolidated groups or controlled groups. These
consistency rules are based on proposed regulations applying section
382 to consolidated and controlled groups. The consistency rules
contained in the proposed regulations have been revised in the final
regulations because the proposed consolidated and controlled group
regulations have not been finalized yet. The final regulations provide
that if a closing-of-the-books election is made with respect to an
ownership change occurring during a consolidated return year, all
allocations with respect to that ownership change must be consistent
with the election. Further consideration will be given to consistency
rules for consolidated groups in the development of final regulations
applying section 382 to these groups. -

B. Limitation Increase Rule

In Notice 87-79, 1987-2 C.B. 387, the IRS announced its intention
to issue regulations that would allow taxpayers to make a closing-of-
the-books election. The Notice stated that, prior to the issuance of
regulations, taxpayers would be required to use the statutory ratable
allocation method unless they obtained a private letter ruling allowing
them to use a different method.
Pursuant to Notice 87-79, the IRS issued a number of private letter
rulings that authorized allocations based on a closing of the
taxpayers' books. Some of these rulings allowed taxpayers to increase
in their section 382 limitation to the extent that any net pre-change
income was offset by net post-change loss in computing taxable income
or loss for the change year. The purpose of the increased limitation
was to put the taxpayer in a position similar to the position it would
have been in had its taxable year ended on the change date.
In the interest of simplicity, the proposed regulations do not
include a rule providing for increases in the annual section 382
limitation in cases in which net post-change loss offsets net pre-
change income. Several commentators questioned the failure to include a
limitation increase rule.
The final regulations retain the approach of the proposed
regulations, in which change year income and losses may be netted
together without limitation. This approach may be either favorable or
unfavorable to taxpayers, depending on the circumstances. This approach
is disadvantageous when it results in the netting of a post-change loss
against pre-change income. Conversely, the approach is advantageous to
taxpayers that are able to net a pre-change loss against post-change
income without limitation. In these cases, if the taxpayers' year had
ended on the change date, the loss so used would have been subject to
the section 382 limitation.
Adoption of a limitation increase rule would add significant
complexity to the regulations. If taxpayers were protected from the
disadvantages of netting a post-change loss against pre- change income,
consistency would require that taxpayers not be allowed the benefit of
netting pre-change loss against post- change income without limitation.
In other words, detailed rules for applying the section 382 limitation
within the change year to limit the use of a loss in the pre-change
portion of the year against income in the post-change period would be
necessary concomitants of a limitation increase rule. To avoid this
complexity, the final regulations allow change year losses to offset
change year income without limitation and do not include a limitation
increase rule.

C. Additional Issues

The preamble to the proposed regulations requested comments on the
interaction of the ratable allocation rules under the proposed
regulations and the built-in gain and loss rules under section 382(h),
particularly with respect to extraordinary items (e.g., an asset sale
not made in the ordinary course of business). A commentator recommended
that the final regulations include both a rule for extraordinary items
and the limitation increase rule (described in paragraph B above).
After due consideration, the IRS and the Treasury Department decided
that rules relating to extraordinary items would add unnecessary
complexity to the final regulations. Thus, the final regulations do not
contain special rules with respect to the allocation of extraordinary
items. The IRS and the Treasury Department may give further
consideration to the desirability of rules addressing extraordinary
items.

D. Effective Date

The regulations apply to ownership changes occurring on or after
June 22, 1994.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small business.

Drafting Information

The principal author of these regulations is Roberta F. Mann,
Office of the Assistant Chief Counsel (Corporate), IRS. However, other
personnel from the IRS and Treasury Department participated in their
development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Sec. 1.382-6 also issued under
26 U.S.C. 382(b)(3)(A), 26 U.S.C. 382(d)(1), 26 U.S.C. 382(m), and
26 U.S.C. 383(d) * * *

Par 2. Section 1.382-1 is amended by revising the entry for
Sec. 1.382-6 and adding additional entries to read as follows:

Sec. 1.382-1 Table of contents.

* * * * *

Sec. 1.382-6 Allocation of income and loss to periods before and
after the change date for purposes of section 382.

(a) General rule.
(b) Closing-of-the-books election.
(1) In general.
(2) Making the closing-of-the-books election.
(i) Time and manner.
(ii) Election irrevocable.
(3) Special rules relating to consolidated and controlled
groups.
(i) Consolidated groups.
(ii) Controlled groups.
(c) Operating rules for determining net operating loss, taxable
income, net capital loss, modified capital gain net income, and
special allocations.
(1) In general.
(2) Adjustment to net operating loss.
(i) Determination of remaining capital gain.
(ii) Reduction of net operating loss by remaining capital gain.
(d) Coordination with rules relating to the allocation of income
under Sec. 1.1502-76(b).
(e) Allocation of certain credits.
(f) Examples.
(g) Definitions and nomenclature.
(1) Change year.
(2) Pre-change period.
(3) Post-change period.
(4) Modified capital gain net income.
(h) Effective date.
* * * * *
Par. 3. The heading of Sec. 1.382-6 is revised, and the text of the
section is added to read as follows:

Sec. 1.382-6 Allocation of income and loss to periods before and after
the change date for purposes of section 382.

(a) General rule. Except as provided in paragraphs (b) and (d) of
this section, a loss corporation must allocate its net operating loss
or taxable income (see section 382(k)(4)), and its net capital loss
(see section 1222(10)) or modified capital gain net income (as defined
in paragraph (g)(4) of this section), for the change year between the
pre-change period and the post-change period by ratably allocating an
equal portion to each day in the year.
(b) Closing-of-the-books election--(1) In general. Subject to
paragraphs (b)(3)(ii) and (d) of this section, a loss corporation may
elect to allocate its net operating loss or taxable income and its net
capital loss or modified capital gain net income for the change year
between the pre-change period and the post-change period as if the loss
corporation's books were closed on the change date. An election under
this paragraph (b)(1) does not terminate the loss corporation's taxable
year as of the change date (e.g., the change year is a single tax year
for purposes of section 172).
(2) Making the closing-of-the-books election--(i) Time and manner.
A loss corporation makes the closing-of-the-books election by including
the following statement on the information statement required by
Sec. 1.382-2T(a)(2)(ii) for the change year: ``THE CLOSING-OF-THE-BOOKS
ELECTION UNDER Sec. 1.382-6(b) IS HEREBY MADE WITH RESPECT TO THE
OWNERSHIP CHANGE OCCURRING ON [INSERT DATE].'' The election must be
made on or before the due date (including extensions) of the loss
corporation's income tax return for the change year.
(ii) Election irrevocable. An election under this paragraph (b) is
irrevocable.
(3) Special rules relating to consolidated and controlled groups--
(i) Consolidated groups. If an election under this paragraph (b) is
made with respect to an ownership change occurring in a consolidated
return year, all allocations under this section with respect to that
ownership change must be consistent with the election.
(ii) Controlled groups. If paragraph (b)(3)(i) of this section does
not apply, and if, as part of the same plan or arrangement, two or more
members of a controlled group (as defined in section 1563(a),
determined by substituting ``50 percent'' for ``80 percent'' each place
that it appears, and without regard to section 1563(a)(4)), have
ownership changes and continue to be members of the controlled group
(or become members of the same other controlled group), a closing-of-
the-books election applies only if the election is made by all members
having the ownership changes.
(c) Operating rules for determining net operating loss, taxable
income, net capital loss, modified capital gain net income, and special
allocations. For purposes of this section, for the change year--
(1) In general--(i) Net operating loss or taxable income is
determined without regard to gains or losses on the sale or exchange of
capital assets; and
(ii) Net operating loss or taxable income and net capital loss or
modified capital gain net income are determined without regard to the
section 382 limitation and do not include the following items, which
are allocated entirely to the post-change period--
(A) Any income, gain, loss, or deduction to which section
382(h)(5)(A) applies; and
(B) Any income or gain recognized on the disposition of assets
transferred to the loss corporation during the post-change period for a
principal purpose of ameliorating the section 382 limitation.
(2) Adjustment to net operating loss--(i) Determination of
remaining capital gain. The amount of modified capital gain net income
(defined in paragraph (g)(4) of this section) allocated to each period
is offset by capital losses to which section 382(h)(5)(A) applies and
capital loss carryovers, subject to the section 382 limitation (in the
case of modified capital gain net income allocated to the post-change
period).
(ii) Reduction of net operating loss by remaining capital gain. The
amount of net operating loss allocated to each period is reduced (but
not below zero) without regard to the section 382 limitation, first by
the modified capital gain net income remaining in the same period, and
then by the modified capital gain net income remaining in the other
period.
(d) Coordination with rules relating to the allocation of income
under Sec. 1.1502-76(b). If Sec. 1.1502-76 applies (relating to the
taxable year of members of a consolidated group), an allocation of
items under paragraph (a) or (b) of this section is determined after
applying Sec. 1.1502-76. Thus, if a short taxable year under
Sec. 1.1502-76 is a change year for which an allocation under this
section is to be made, the allocation under this section applies only
to the items allocated to that short taxable year under Sec. 1.1502-76.
(e) Allocation of certain credits. The principles of this section
apply for purposes of allocating, under section 383, excess foreign
taxes under section 904(c), current year business credits under section
38, and the minimum tax credit under section 53. The loss corporation
must use the same method of allocation (ratable allocation or closing-
of-the-books) for purposes of sections 382 and 383.
(f) Examples. The rules of this section are illustrated by the
following examples:

Example 1. (i) Assume that the loss corporation, L, a calendar
year taxpayer with a May 26, 1995, change date, determines a section
382 limitation under section 382(b)(1) of $100,000. Thus, for the
change year, its section 382 limitation is $100,000 x (219/
365)=$60,000. L makes the closing-of-the- books election under
paragraph (b) of this section.
(ii) Assume that L has a $150,000 capital loss carryover (from
its 1994 taxable year) and a $300,000 net operating loss carryover
(from its 1994 taxable year) to the change year. L recognizes, in
the pre-change period, $200,000 of ordinary loss, and, in the post-
change period, $150,000 of capital gain and $100,000 of ordinary
income. Assume that section 382(h) does not apply to the capital
gain or the ordinary income.
(iii) L has a $100,000 net operating loss for the change year
($200,000 pre-change loss less $100,000 post-change income), as
determined under paragraph (c)(1)(i) of this section. Because L has
no current year capital losses, L's $150,000 capital gain recognized
in the post-change period is its modified capital gain net income
for the change year (as defined at paragraph (g)(4) of this
section). L allocates $100,000 of net operating loss to the pre-
change period and $150,000 of modified capital gain net income to
the post-change period.
(iv) Under paragraph (c)(2)(i) of this section, L uses its
capital loss carryover to offset its modified capital gain net
income allocated to the post-change period, subject to its section
382 limitation. L's section 382 limitation is $60,000, so L uses
$60,000 of its capital loss carryover to offset $60,000 of its
$150,000 modified capital gain net income. L has absorbed its entire
section 382 limitation for the change year and has $90,000 of
modified capital gain net income remaining in the post-change
period.
(v) Under paragraph (c)(2)(ii) of this section, L offsets its
$100,000 net operating loss allocated to the pre-change period by
the $90,000 of modified capital gain net income remaining in the
post-change period, without regard to the section 382 limitation,
thereby reducing its pre-change net operating loss to $10,000.
(vi) From its 1994 taxable year, L will carry over $90,000 of
capital loss and $300,000 of net operating loss to its 1996 taxable
year. From its 1995 taxable year, L will carry over $10,000 of net
operating loss subject to the section 382 limitation to its 1996
taxable year.
Example 2. (i) Assume the facts of Example 1, except that L does
not make the closing-of-the-books election under paragraph (b) of
this section.
(ii) L ratably allocates its $100,000 net operating loss and its
$150,000 of modified capital gain net income for the change year.
$40,000 of net operating loss ($100,000 x (146/365)) and $60,000
of modified capital gain net income ($150,000 x (146/365)) are
allocated to the pre-change period. $60,000 of net operating loss
($100,000 x (219/365)) and $90,000 of modified capital gain net
income ($150,000 x (219/365)) are allocated to the post-change
period.
(iii) Under paragraph (c)(2)(i) of this section, L uses its
capital loss carryovers to offset modified capital gain net income.
The capital loss carryovers offset the $60,000 modified capital gain
net income allocated to the pre-change period without limitation.
Subject to the section 382 limitation, the remaining $90,000 of
capital loss carryovers offset the modified capital gain net income
allocated to the post-change period. Accordingly, L uses $60,000 of
its capital loss carryovers to offset $60,000 of its $90,000
modified capital gain net income allocated to the post-change
period. L has absorbed its entire section 382 limitation for the
change year.
(iv) Under paragraph (c)(2)(ii) of this section, L's $60,000 net
operating loss allocated to the post-change period is offset by its
remaining $30,000 of post-change modified capital gain net income,
reducing its post-change net operating loss to $30,000.
(v) From its 1994 taxable year, L will carry over $30,000 of
capital loss and $300,000 of net operating loss to its 1996 taxable
year. From its 1995 taxable year, L will carry over $70,000 of net
operating loss ($40,000 pre-change +$30,000 post-change) to its 1996
taxable year. The $40,000 pre-change portion of that carryover is
subject to the section 382 limitation.

(g) Definitions and nomenclature. The terms and nomenclature used
in this section and not otherwise defined herein have the same meanings
as in sections 382 and 383 and the regulations thereunder. For purposes
of this section:
(1) Change year. A loss corporation's taxable year that includes
the change date is its change year.
(2) Pre-change period. The pre-change period is the portion of the
change year ending on the close of the change date.
(3) Post-change period. The post-change period is the portion of
the change year beginning with the day after the change date.
(4) Modified capital gain net income. A loss corporation's modified
capital gain net income is the excess of the gains from sales or
exchanges of capital assets over the losses from such sales or
exchanges for the change year, determined by excluding any short-term
capital losses under section 1212.
(h) Effective date. This section applies to ownership changes
occurring on or after June 22, 1994.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as
follows:

Authority: 26 U.S.C. 7805.

Sec. 602.101 [Amended]

Par. 5. Section 602.101(c) is amended by adding the entry ``1.382-
6. . . .1545-1381'' in numerical order to the table.

Dated: June 2, 1994.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved:
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-14970 Filed 6-21-94; 8:45 am]
BILLING CODE 4830-01-U