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Proposed IRS Regulations Address Aggregation of Basis in Corporate Stock Distributions.

(Parker Tax Publishing June 28, 2015)

The IRS has issued proposed regulations requiring certain partners to aggregate their bases in stock distributed by the partnership for purposes of applying Code Sec. 732(f), in order to limit instances of basis reduction or gain recognition. The regulations are intended to prevent circumvention of the General Utilities doctrine repeal. REG-138759-14.

Background

In General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), the Supreme Court held that corporations generally could distribute appreciated property to their shareholders without the recognition of any corporate level gain (the General Utilities doctrine). Beginning in 1969 and ending with the Tax Reform Act of 1986 Congress enacted a series of statutory changes that limited and ultimately repealed the General Utilities doctrine.

The IRS has released proposed regulations for Code Sec. 732 under REG-138759-14 that would require consolidated group members that are partners in the same partnership to aggregate their bases in stock distributed by the partnership for the purpose of applying Code Sec. 732(f), in order to limit the application of rules that might otherwise cause basis reduction or gain recognition. Like the concurrently released regulations under T.D. 9722, which prevent corporations from avoiding gains under Code Secs. 311 and 336, the proposed regulations are intended to prevent taxpayers from contravening the purposes of the General Utilities repeal.

Congress enacted Code Sec. 732(f) due to concerns that a corporate partner could otherwise negate the effects of a basis step-down to distributed property required under section 732(b) by applying the step-down against the basis of distributed stock of a corporation (distributed corporation). Code Sec. 732(f) generally precludes this result by requiring that either the distributed corporation must reduce the basis of its property or the corporate partner must recognize gain (to the extent the distributed corporation is unable to reduce the basis of its property).

Specifically, Code Sec. 732(f) provides that if: (1) a corporate partner receives a distribution from a partnership of stock in another corporation (distributed corporation), (2) the corporate partner has control of the distributed corporation (i.e., ownership of stock meeting the requirements of Code Sec. 1504(a)(2)) immediately after the distribution or at any time thereafter (the "control requirement"), and (3) the partnership's basis in the stock immediately before the distribution exceeded the corporate partner's basis in the stock immediately after the distribution, then the basis of the distributed corporation's property must be reduced by this excess.

The IRS believes that as currently applied, Code Sec. 732(f) may be too broad in some circumstances and too narrow in others. For example, corporate partners may inappropriately avoid the purposes of Code Sec. 732(f) by engaging in transactions in which they receive property held by a distributed corporation without reducing its basis to account for basis reductions under Code Sec. 732(b) made when the partnership distributed stock of the distributed corporation to the corporate partner.

Aggregation of Code Section 732(b) Basis Adjustments

Although Code Sec. 732(f) generally applies on a partner-by-partner basis, the IRS states that in certain circumstances, it is appropriate to aggregate the bases of consolidated group members in a partnership for purposes of applying Code Sec. 732(f). For example, basis aggregation may be appropriate when two or more corporate partners in the same consolidated group (member-partners) receive a deemed distribution of stock in a distributed corporation either because, (1) the partnership elects to be treated as an association taxable as a corporation, or (2) one corporate partner acquires all of the interests in the partnership causing the partnership to liquidate. In these instances, Code Sec. 732(b) may cause one member-partner to increase the basis of distributed stock while another member-partner reduces the basis of distributed stock by an equivalent amount.

Under current law, Code Sec. 732(f) may require the member-partner whose basis is reduced to recognize gain or to reduce the basis of the distributed corporation's property, with no offsetting loss or increase to the basis of the distributed corporation's property with respect to the member-partner whose basis is increased.

The proposed regulations provide for the aggregation of basis within the same consolidated group (as defined in Reg. Sec. 1.1502-1(h)), for purposes of Code Sec. 732(f), when two conditions are met:

(1) Two or more of the corporate partners receive a distribution of stock in a distributed corporation;

(2) The distributed corporation is or becomes a member of the distributee partners' consolidated group following the distribution.

Under this rule, Code Sec. 732(f) only applies to the extent that the partnership's adjusted basis in the distributed stock immediately before the distribution exceeds the aggregate basis of the distributed stock in the hands of all members of the distribute corporate partner's consolidated group immediately after the distribution.

Gain Elimination Transactions

The proposed regs also addresses IRS concerns that some corporate partners might eliminate gain in the stock of a distributed corporation while avoiding the effects of a basis step-down in transactions in which the corporate partner's ownership of the distributed corporation does not satisfy the control requirement. For example, a distributed corporation not controlled by a corporate partner might subsequently merge into the corporate partner in a reorganization under Code Sec. 368(a) in which gain is not recognized as part of a plan or arrangement. In this situation, the gain inherent in the stock of the distributed corporation is eliminated, but the basis of the distributed corporation's property is not reduced. If Code Sec. 732(f) does not apply to this transaction, then the basis step-down is negated, contravening the purposes of Code Sec. 732(f) and General Utilities repeal.

Accordingly, the proposed regulations provide that, in the event of a gain elimination transaction, Code Sec. 732(f) shall apply as though the corporate partner acquired control (as defined in Code Sec. 732(f)(5)) of the distributed corporation immediately before the gain elimination transaction.

The proposed regulations are not effective until finalized.

For a discussion on partnership basis in distributed property, see Parker Tax ¶23,525. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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