Temp. Regs. on Attribute Reduction When a Consolidated Group Member Realizes DOI Income

Temporary regulations (TD 9089) address reducing tax attributes when a consolidated group member realizes discharge of indebtedness (DOI) income on debt that is not an intercompany obligation under Regs. Sec. 1.1502-13(g). Essentially, Temp. Regs. Sec. 1.1502-28T adopts a consolidated approach to attribute reduction and applies to DOI occurring after Aug. 29, 2003.

Background

When a debtor corporation is in bankruptcy or insolvent (to the extent of the debtors insolvency) or has qualified farm debt, and such debt is discharged, instead of including the discharged debt in income, it must reduce its tax attributes by
the debt discharged, under Sec. 108(b)(1). Unless the corporation makes an election under Sec. 108(b)(5), tax attributes are reduced in the following order, under Sec. 108(b)(2): (1) net operating losses and net operating loss carryovers; (2) general business credits under Sec. 38; (3) minimum tax credits under Sec. 53(b); (4) net capital losses and capital loss carryovers; (5) asset basis; (6) passive activity loss and credit carryovers under Sec. 469(b); and (7) foreign tax credits and foreign tax credit carryovers. 

Sec. 108 generally offers a debtor a temporary tax deferral, rather than an income exclusion, by making attributes unavailable to offset income in later years. Until the temporary regulations were released, uncertainty existed as to whether Sec. 108(b) should be applied on a separate-entity or a consolidated basis when the debtor was a consolidated group member.

Temporary Regulations

As noted above, Temp. Regs. Sec. 1.1502-28T adopts a consolidated approach that reduces all consolidated tax attributes available to the debtor (including those attributable to members other than the debtor member (DM)). In contrast, because the basis of assets held by members other than the DM are not directly available to offset the DMs income, the temporary regulations reduce the members asset bases only in limited circumstances. Temp. Regs. Sec. 1.1502-28T(a)(2)(4) adopt the following ordering rules for attribute reduction:

• DMs attributes. Under Temp. Regs. Sec. 1.1502-28T(a)(2), the DMs attributes are reduced first, including (1) consolidated attributes attributable to the DM; (2) attributes arising in the DMs separate return limitation years (SRLYs); and (3) basis of the DMs property.

• Look-through rule. According to Temp. Regs. Sec. 1.1502-28T(a)(3)(ii), if the DMs attribute reduced is the basis of stock of another group member, then solely for purposes of Secs. 108 and 1017, the lower-tier member is treated as a DM with excluded DOI income in the amount of the stock-basis reduction (the look-through rule). When the look-through rule applies, the lower-tier members attributes are subject to reduction next. To the extent the stock-basis reduction exceeds the lower-tier members tax attributes, such excess does not reduce tax attributes attributable to any other group member.

•  Other members attributes. Under Temp. Regs. Sec. 1.1502-28T(a)(4), to the extent that excluded DOI income is not applied to reduce the tax attributes attributable to the DM or a lower-tier member (by reason of the look-through rule), the excess reduces the groups remaining consolidated tax attributes, including those attributable to members that arose (or treated as arising) in a SRLY, to the extent the member that realizes excluded DOI income is a member of the SRLY subgroup as to such attribute. However, basis in assets of other members is not subject to reduction.

In addition, TD 9089 amends Regs. Sec. 1.1502-32 and -19. Temp. Regs. Sec. 1.1502-32T treats as tax-exempt income (in determining positive basis adjustments to the DMs stock) any excluded DOI income, to the extent that such income reduces any group members tax attributes or credits. Temp. Regs. Sec. 1.1502-19T provides that an excess loss account attributable to DM stock must be included in income only to the extent that any amount discharged is excluded from gross income or is not treated as tax-exempt income (e.g., to the extent applied to reduce tax attributes).

Implications

Temp. Regs. Sec. 1.1502-28Ts consolidated-attribute-reduction approach is a significant development. Essentially, the Service and Treasury have determined that when a group member realizes excluded DOI income, the attributes of other group members are subject to reduction once the DMs attributes have been exhausted. However, TD 9089 does not affect the law applicable to debt discharges occurring before the temporary regulations effective date. Although consolidated attribute reduction is consistent with the Supreme Courts decision in United Dominion Industries, Inc., 532 US 822 (2001) (dealing with specified liability losses in the consolidated context) and the Services position that Sec. 108(b) should be applied on a consolidated basis (see, e.g., FSA 199912007), until now, no rules have been issued requiring this result.

From Mark Yecies, Washington, DC