Final Regs Issued on Closing-of-Books Election for Loss Corps

 [4830-01-u]

 ACTION: Final regulations.

 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

Treasury Decision 8546

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 * * *

Section 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 section 1.382-6 and adding additional entries to read as follows:

 SECTION 1.382-1 TABLE OF CONTENTS.

SECTION 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 section 1.382-2T(a)(2)(ii) for the change year: "THE CLOSING-OF-THE-BOOKS ELECTION UNDER SECTION 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 SECTION 1.1502-76(B). If section 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 section 1.1502-76. Thus, if a short taxable year under section 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 section 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 [INSERT DATE THIS DOCUMENT IS PUBLISHED IN THE FEDERAL REGISTER].

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.

SECTION 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.