Prop. Regs. Bar Use of Basis Shifting to Create Artificial Losses

The Service issued proposed regulations (REG-150313-01) on how to treat the basis of redeemed stock when a stock redemption is treated as a distribution under Sec. 301.

For such distributions, current regulations preserve and protect the redeemed stock’s basis from elimination, by allowing "proper adjustments" to be made to the redeeming corporation’s remaining stock. The basis is also preserved in transactions subject to Sec. 304, in which immediately after the transaction, the seller owns acquiring corporation stock. In certain transactions, however, taxpayers sometimes take the position that certain adjustments are proper, even if the adjustments shift basis from a person not subject to U.S. tax to one who is, or to stock other than that of the redeeming corporation; see, e.g., Notice 2001-45.

Proposed Changes

The proposed regulations remove the Regs. Sec. 1.302-2(c) proper-adjustment method, and add new Prop. Regs. Sec. 1.302-5, for redemptions taxable as dividends. In general, under Prop. Regs. Sec. 1.302-5, if an amount received in a stock redemption is treated as a dividend distribution, an amount equal to the redeemed stock’s basis (after adjusting for certain provisions, including Sec. 301(c)(2)), will be treated, on the redemption date, as a loss recognized on a stock disposition. The proposed regulations provide guidance on when to take the loss into account; generally, this is a date later than the redemption date. The loss’s attributes (e.g., the character and source) are determined on the redemption date.

Generally, under the proposed regulations, a taxpayer can take a loss attributable to the redeemed stock’s basis (not previously considered) into account when, and to the extent that, the shareholder must take into account gain from an actual or deemed stock sale or exchange of redeeming corporation stock (the "accelerated inclusion date") and the balance when the facts and circumstances causing the redemption to be treated as a dividend distribution no longer exist (the "final inclusion date"). Specifically, the proposed regulations define the "final inclusion date" as:

1. The first date on which the redeemed shareholder would satisfy Sec. 302(b)(1), (2) or (3) criteria if the facts and circumstances that exist on such date had existed immediately after the redemption (subject to certain exceptions for acquisitive and divisive transactions, and whether the redeemed shareholder is a partnership, S corporation, estate or trust); or

2. The last date on which there is no later date on which the redeemed shareholder could take the loss into account (e.g., if the redeemed shareholder is a corporation, the final inclusion date would include the date such corporation transferred its assets in a Sec. 331 liquidation).

The proposed regulations define "accelerated inclusion date" as a date (other than the final inclusion date) on which the redeemed shareholder must take into account gain on an actual or deemed stock sale or exchange of redeeming corporate stock. For example, the accelerated inclusion date could include the date on which the redeemed shareholder receives a distribution as to the redeeming corporation’s stock, to which Sec. 301(c)(3) applies.

The proposed regulations define "redeemed shareholder" as a person whose stock is redeemed in a transaction in which all or a portion of the redemption proceeds are treated as a dividend (subject to certain exceptions when the redeemed shareholder is a partnership, S corporation, estate or trust).

The proposed regulations also provide special application rules. For example, any loss attributable to redeemed stock basis (not permitted to be taken into account) is treated as a net operating loss carryforward or a capital loss carryforward, as applicable, for Secs. 382 and 383 purposes. In addition, the proposed rules provide that, for Secs. 172 and 1212 purposes, any portion of a loss attributable to the redeemed stock’s basis is treated as occurring in the tax year in which the redeemed shareholder can take such loss into account, not in the tax year of the redemption that gave rise to such loss.

Further, under the proposed regulations, special rules address (1) interest expense apportionment under Sec. 864(e), (2) the effect of a loss attributable to the basis of redeemed stock on earnings and profits and (3) excess loss accounts in the consolidated return context, as well as special rules that depend on whether the redeemed shareholder is a partnership, S corporation, estate or trust.

The proposed regulations also amend Sec. 304 regulations to reflect the proposed amendments to the Sec. 302 regulations, as well as the various statutory changes that have been made to the Sec. 304 over the years.

Implications

The proposed regulations affect shareholders whose stock in an issuing corporation is either redeemed or acquired by a corporation related to the issuer. If finalized, they could change the location and timing of any related gain or loss relative to that under the current rules.

From Mark L. Yecies, Washington, DC