M&A and Reinsurance Panel Insurance Tax Conference November 5, 2010 Jeff Vogel, KPMG LLP Lori Jones, Scribner, Hall & Thompson, LLP Stephen Collier, Genworth Financial, Moderator 1
Overview • Loss Preserving Transactions in the Current Environment • Worthless Stock Deductions • Section 338 Elections • Insurance and Section 338 Interplay • Granite Trust Transactions • Unified Loss Rules • Potential Acquisition Traps 2
Worthless Stock LossRequirements for a Capital Loss (Section 165(g)(1)) • A corporation may claim a capital loss with respect to the stock of a subsidiary (“Loss Co”) under section 165(g)(1) if: • Loss Co’s stock is “worthless” in the tax year that the loss is claimed • To establish worthlessness, Loss Co must: • have had value (liquidating or potential) at some point during the tax year, but by year end have no liquidating value (i.e., liabilities > FMV of assets) and no potential value, (with the lack of potential value generally indicated by an “identifiable event” such as a liquidation), and, • if Loss Co is a consolidated subsidiary, meet the consolidated return timing standards under Reg. § 1.1502-80(c) • Note that the amount of the worthless stock loss for a consolidated subsidiary is subject to the unified loss rule under Reg. § 1.1502-36
Worthless Stock LossRequirements for an Ordinary Loss (Section 165(g)(3)) • A domestic corporation may claim an ordinary loss with respect to the stock of Loss Co under section 165(g)(3) if: • Worthlessness is established for Loss Co’s stock (i.e., the same test as under section 165(g)(1)); • Loss Co is “affiliated” with shareholder (i.e., shareholder must directly own Loss Co stock that has at least 80% of the total voting power and at least 80% of the total value of Loss Co); AND • more than 90% of Loss Co’s aggregate “gross receipts” are from sources other than royalties, rents, dividends, interest, annuities, and gains from the disposition of stocks or securities (i.e., passive income) • The 90% test applies over the entire period of subsidiary’s existence and not just the period of affiliation with the parent. Rev. Rul. 75-186 • Note that the amount of the worthless stock loss for a consolidated subsidiary is subject to the unified loss rule under Reg. § 1.1502-36
Worthless Stock LossEvolution of Gross Receipts Test in Consolidation – PLR 200710004 • PLR 200710004 broke new ground with two of its rulings. • First: • Gross receipts are an item under section 381(c) • Thus, gross receipts of subsidiaries of Loss Co that liquidated or merged into Loss Co in a section 381(a) transaction are included in Loss Co’s gross receipts as if Loss Co had directly earned such receipts • Prior intercompany distributions from such lower-tier subsidiaries to Loss Co are eliminated, “as appropriate, to prevent duplication” • Subsequent rulings confirm that the section 381 approach applies regardless of whether the lower-tier subsidiaries are domestic or foreign (e.g., PLR 201006003) • Section 381 approach appears conceptually correct, but may be administratively difficult to apply
Worthless Stock LossEvolution of Gross Receipts Test in Consolidation – PLR 200710004 (Cont’d) • Second: • Dividends from lower-tier consolidated subsidiaries of Loss Co (that are not covered by the section 381 ruling) are treated as gross receipts from passive sources to the extent they are attributable to the distributing member’s gross receipts from passive sources (a “look through” or single entity approach for intercompany distributions) • In applying the look through approach, “dividends will be attributed pro rata to the gross receipts that gave rise to the E&P from which the dividend was distributed” • Subsequent PLRs depart from the approach of looking to E&P • Compare TAM 200727016, denying a look through approach for dividends received by Loss Co from foreign subsidiaries • See also PLR 200932018, which is generally consistent with PLR 200710004 in applying the section 381 approach and the look through approach for intercompany dividends
Worthless Stock LossEvolution of Gross Receipts Test in Consolidation – PLR 201006003 • Continues the section 381 approach (and reiterates that prior “intercompany distributions” are eliminated to prevent duplication) • Clarifies the look through approach by denying the approach for intercompany distributions made out of E&P and received by Loss Co in a tax year beginning prior to July 12, 1995 (i.e., under the prior version of the intercompany transaction regulations)
Worthless Stock LossEvolution of Gross Receipts Test in Consolidation – PLR 201011003 • Expands look through approach to ALL intercompany transactions. • Loss Co includes in its gross receipts all amounts from “intercompany transactions” (as described in the current regulations under Reg. § 1.1502-13), and such amounts are treated as gross receipts from passive sources to the extent they are attributable to the counterparty’s gross receipts from passive sources • Look through is required until a source of income from outside the group is reached (i.e., the counterparty member applies the same methodology for its gross receipts from other members until the ultimate counterparty that transacts with outside parties is reached) • Continues the section 381 approach • Loss Co must eliminate gross receipts from all intercompany transactions with the transferor, “as appropriate, to prevent duplication”
Worthless Stock LossActive vs. Passive Income • Rev. Rul. 88-65 held rental receipts received in connection with active vehicle leasing business not treated as passive income under section 165(g)(3). See also G.C.M. 39746. (But see Comm’r v. Adam, Meldrum and Anderson Co., 215 F. 2d 163 (2d Cir. 1954). aff’g 19 T.C. 1130 (1953) which took a literal approach to section 165(g)(3)). • LTR 200924040 excluded licensing fees from definition of royalties under section 165(g)(3)(B), and allowed ordinary loss on worthlessness of affiliated corporation. Licensing fees earned by corporation arising from sources that are integral to development, manufacturing, production or support of customized software applications were viewed as active gross receipts. • PLR 200003039 excluded foreign subsidiary’s income from vehicle rentals and fees for various administrative and other services from passive income under section 165(g)(3) because the taxpayer provided related services. • PLR 9218038 treated a thrift’s lending operations as not giving rise to passive income and allowed an ordinary loss on the thrift’s stock under section 165(g)(3). 9
Worthless Stock LossInsurance Company Rulings • FSA 1159 concluded interest, dividends and rent were not interest and dividends under section 165(g)(3) because an insurance business is actively managed, citing Rev. Rul. 88-65. • TAM 9538005 concluded section 165(g)(3) applied to insolvent insurance subsidiary stock. • TAM 9723011 announced IRS was reconsidering TAM 9538005 with a view toward its revocation. • TAM 9817002 concluded that section 165(g)(3) did not apply to the insurance company in TAM 9538005 (which was officially withdrawn) because a disposition of the assets in hands of insurance company would give rise to capital rather than ordinary treatment. Section 7805(b) relief was granted. 10
Interplay with Section 165(g) and Check-the-Box Elections • Rev. Rul. 2003-125 held in Scenario 2 that the change in classification of a foreign entity from a corporation to a disregarded entity resulted in a worthless stock deduction under section 165(g) when the fair market value of the foreign entity’s assets, including intangible assets, did not exceed its liabilities immediately before the deemed liquidation. • FSA 200226004 (June 28, 2002) concluded that there was insufficient evidence to support the taxpayer’s claim of worthlessness where the taxpayer changed the classification from corporations to partnerships and claimed worthless stock deductions. 11
Section 338(h)(10) Election • In the case of a section 338(h)(10) election, T must be an eligible target corporation • Member of a selling consolidated group • Affiliated target (SH has direct section 1504(a)(2) ownership) • An S corporation • The common theme for eligibility is that an actual asset sale by one of these corporations would result in only one level of tax (said differently, the shareholders of the corporations ordinarily can escape tax on stock gain)
Section 338(h)(10) Election - Effects of Election S P S P Assets $ T New T T New T $ $ Sale of T assets for $ and liability assumption Liquidation into S
Section 338(h)(10) and Insurance Company Target • Under Reg. § 1.338-11, the deemed sale of insurance contracts pursuant to section 338 by an insurance company is treated as an assumption reinsurance transaction between old target, as the reinsured and ceding company, and new target, as the reinsurer and acquiring company, at the close of the acquisition date. • There are special rules in the regulations dealing with: • Allocation of ADSP and AGUB to specific insurance contracts (Reg. § 1.338-11(b)(2)) • The amount of the reinsurance premium (Reg. § 1.338-11(c)(2)) • The treatment of reserve increases by new target after the deemed sale (Reg. § 1.338-11(d)) • The effect on section 846(e) (Reg. § 1.338-11(e)), section 848 (Reg. § 1.338-11(f)), policyholders surplus accounts (Reg. § 1.338-11(g)) and section 847 payments (Reg. § 1.338-11(h))
Pre-Election Assets & Liabilities Cash 10 Securities 30 Equipment 10 Life Ins. In-force* 17 Goodwill - Reserves 50 Other Liabilities 0 ----- Purchase Price 16 DAC General Deductions** 20 *Life insurance in force valued with a limitation on value as if the maximum gross reinsurance premium is old T’s tax reserves. After Election, Allocation of ADSP & AGUB Class I 10 Class II 30 Class V 10 Class VI 16 Class VII 0 66 ADSP (16+50)=66 AGUB (16+50)=66 **Not including any portion of the ceding commission in the deemed assumption reinsurance. Reg. § 1.338-11(c)(4), Example 1 Positive Ceding Commission
Old T Section 848 DAC Calculation Reinsurance Premium* 50 Ceding Commission** (16) Net Negative Consideration 34 DAC Rate 7.7% Net Negative Cap. Amount 2.62 Deemed Assumption Reinsurance Decrease in reserves 50 Reinsurance Premium Paid (50) Ceding Commission 16 Section 848 deduction*** (2.62) Taxable Income 13.38 *Deemed to equal the tax reserves transferred. **Determined by ADSP formula. **Pre-sale DAC balance is assumed to equal 2.62
New T Section 848 DAC Calculation Reinsurance premium* 50 Ceding Commission (16) Net Positive Consideration 34 DAC Rate 7.7% Net Positive Cap. Amount** 2.62 Ceding Commission Deduction Ceding Commission 16 Amt. capitalized –Section 197(f)(5) (13.38) Deduction – Section 848(g) 2.62 *Deemed to equal the tax reserves transferred. **The section 848 (c) general deduction limitation is 20
New T Deemed Assumption Reinsurance Reinsurance Premium 50 Increase in Reserves (50) Ceding Commission (2.62) General Deductions* (17.38) Taxable loss (20.00) *General deductions 20 less the positive DAC capitalization amount 2.62.
Pre-Election Assets & Liabilities Cash 10 Securities 30 Equipment 10 Life Insurance In-force* 0 Goodwill, etc. - Reserves 50 Other Liabilities 0 ----- Purchase Price 16 DAC General Deductions 20 * Life insurance in force is valued with a limitation on value as if the maximum gross reinsurance premium is old T’s tax reserves. After Election, Allocation of ADSP & AGUB Class I 10 Class II 30 Class V 10 Class VI 0 Class VII 16 66 ADSP (16+50)=66 AGUB (16+50)=66 Reg. § 1.338-11(c)(4), Example 2 Negative Ceding Commission
Old T Section 848 DAC Calculation Reinsurance Premium* 50 Ceding Commission** 0 Net Negative Consideration 50 DAC Rate 7.7% Net Negative Cap. Amount 3.85 Deemed Assumption Reinsurance Decrease in Reserves 50 Reinsurance Premium Paid (50) Ceding Commission 0 Section 848 deduction (3.85) Taxable income (3.85) *Deemed to equal tax reserves transferred **Determined by ADSP formula
New T Section 848 DAC Calculation Reinsurance Premium 50 Ceding Commission 0 Net Negative Consideration 50 DAC Rate 7.7% Net Negative Cap. Amount 3.85 Deemed Assumption Reinsurance Increase in Reserves (50) Reinsurance Premium 50 Ceding Commission 0 General Deductions* (16.15) Taxable Loss (16.15) *General deductions 20 less the positive capitalization amount 3.85.
Section 338 and Section 165(g) • Section 338(h)(10) allows the sale of target stock to be disregarded and treated as a deemed asset sale followed by a deemed liquidation of old target. • If target is insolvent within the meaning of Rev. Rul. 2003-125 at the time of the deemed liquidation, the shareholder’s loss on target stock will be recognized (as opposed to being disregarded if the liquidation is non-taxable under sections 332 and 337) and a worthless stock deduction under section 165(g) can be recognized, subject to Reg. § 1.1502-36 if applicable. 22
PLR 201011003 • PLR 201011003 concluded that Parent could claim a worthless stock deduction under section 165(g)(3) upon the deemed liquidation of its wholly-owned LLC/loss co. (LossCo) as a result of a section 338(h)(10) election, subject to the application of Reg. § 1.1502-36. • Under the facts, on Date 1, Parent contributed part of a note (originally issued by LossCo) to LossCo. It was represented that LossCo was insolvent within Rev. Rul. 2003-125. (The contribution of the note was disregarded in determining solvency. See Rev. Rul. 68-602.) LossCo stock was sold for cash and voting common and non-voting preferred equity interests and LossCo and its subsidiaries filed for relief under Chapter 11 immediately after the transactions. • As discussed earlier, the IRS adopted a look-through approach to all intercompany transactions and continued the section 381 approach. 23
Granite Trust – PLR 201014002 FP Stock of F1 sold for FMV X % of F1 US F1 Subs • US sells x percent of its common and preferred stock in F1 to FP for fair market value • Stock values were apparently unknown at the time of the ruling • If value is less than $1, the sales price will be $1 to evidence nominal consideration • F1 converts to a ULC (the Conversion), resulting in a deemed liquidation of F1
Granite Trust – PLR 201014002 (Cont’d) FP Stock of F1 sold for FMV X % of F1 US F1 Subs • If the F1 common and preferred shares are all worthless, any worthless stock loss otherwise allowable to F1’s shareholders will not be disallowed under section 267(a)(1) or deferred under section 267(f)(2) • If the F1 common and preferred shares all have value: • The sale of stock to F1 is a section 1001 exchange (not section 304) • US will account for any loss on the sale under section 267(f); the loss will remain deferred after the Conversion (until FP and US are no longer in a controlled group relationship)
Granite Trust – PLR 201014002 (Cont’d) FP Stock of F1 sold for FMV X % of F1 US F1 Subs • If the F1 preferred shares have value but the common shares are worthless: • Any worthless stock loss otherwise allowable to F1’s shareholders on the common stock will not be disallowed under section 267(a)(1) or deferred under section 267(f)(2) • The sale of the preferred stock to F1 is a section 1001 exchange (not section 304) • US will account for any loss on the sale of the preferred stock under section 267(f); the loss will remain deferred after the Conversion (until FP and US are no longer in a controlled group relationship) • Neither section 332 nor section 368(a)(1)(C) will apply to the deemed liquidation of F1 • A shareholder of F1 that receives a liquidating distribution will recognize gain or loss; a loss will not be disallowed or deferred under section 267(a)(1) or section 267(f)(2)
Granite Trust – Background on Section 267 • Section 267(a)(1) – Disallows loss on sales between related persons (as defined in section 267(b)). Does not apply to any loss of the distributing corporation (or the distributee) in the case of a distribution in complete liquidation • Section 267(f)(2) – Defers losses from sales between members of the same controlled group to which section 267(a)(1) would otherwise apply, until the property is transferred outside the controlled group and there would be recognition of the loss under consolidated return principles or until such other time prescribed by regulations • Uses section 1563 definition of controlled group, with modifications. The most important modification is using a 50 percent threshold rather than an 80 percent threshold
Granite Trust – Background on Section 267 • Reg. § 1.267(f)-1 cross references the timing principles of Reg. § 1.1502-13 • Similarities between Reg. § 1.1502-13 and Reg. § 1.267(f)-1: • Deferred transaction model, preserves location • Matching and acceleration rules • Differences: • Applies only to losses • Applies on a controlled group basis • Applies only to sales or exchanges of property • Incorporates only the timing aspects of the matching and acceleration rules of Reg. § 1.1502-13, but generally not the attribute redetermination rules
Granite Trust – Background on Section 267 (Cont’d) • Attribute redetermination under Reg. § 1.1502-13 (generally not available under Reg. § 1.267(f)-1): • Attributes include character, source, treatment as excluded from gross income or as a noncapital nondeductible amount. Reg. § 1.1502-13(b)(6) • Separate entity items of S and B are generally redetermined to the extent necessary to produce the effect of a transaction between divisions of a single corporation. Reg. § 1.1502-13(c)(1); compare Reg. § 1.1502-13(d)(1)(ii) • Special rules apply for determining whether items are redetermined to be treated as excluded from gross income or as noncapital, nondeductible amounts. Reg. § 1.1502-13(c)(6) • Cross-chain intercompany sale of stock at a gain followed by a liquidation under section 332 – the gain is generally taken into account. Reg. § 1.1502-13(f)(7)(i)(Ex. 5(b)); but see Reg. § 1.1502-13T(c)(6)(ii)(C) • Cross-chain intercompany sale of stock at a loss followed by a liquidation under section 332 – the loss is generally redetermined to be a noncapital, nondeductible amount. Reg. § 1.1502-13(f)(7)(i)(Ex. 5(c)) • Reg. § 1.267(f)-1(c)(1)(iv) – if a loss deferred under section 267(f) would be redetermined to be noncapital, nondeductible under the principles of Reg. § 1.1502-13, it remains deferred until S and B are no longer in a controlled group relationship
Granite Trust – Background on Section 267 Example 1 P P 100% of S2 stock cash S2 S1 S1 S2 Stock: AB=$100 FMV=$10 S2 P, S1, and S2 are members of a consolidated group. S1’s basis in S2 stock is $100 and FMV is $10 S1 sells 100 percent of the S2 stock to P. S1’s $90 loss is deferred under Reg. § 1.1502-13(c)(2)(ii) S2 later liquidates. S1’s deferred loss is redetermined to be a noncapital, nondeductible amount
Granite Trust – Background on Section 267 Example 2 FP FP 100% of S1 stock cash S1 P P S1 Stock: AB=$100 FMV=$10 S1 P and S1 are members of a consolidated group (but FP is not) P sells 100 percent of the S1 stock to FP. P’s $90 loss is deferred under Reg. § 1.267(f)-1(a)(2). (Not a section 304 transaction, per Rev. Rul. 74-605) S1 later liquidates. To the extent the loss would be redetermined to be a noncapital, nondeductible amount under the principles of Reg. § 1.1502-13, it continues to be deferred until P and FP are no longer in a controlled group relationship
Granite Trust – Background on Section 267 Example 3 FP FP 21% of S1 stock cash P P 21% S1 Stock: AB=$100 FMV=$10 79% S1 S1 • P and S1 are members of a consolidated group (but FP is not) • P sells 21 percent of the S1 stock to FP. P’s $18.90 loss is deferred under Reg. § 1.267(f)-1(a)(2) • S1 later liquidates in a taxable transaction. Would P’s deferred loss be redetermined to be a noncapital, nondeductible amount under the principles of Reg. § 1.1502-13? Compare PLR 200812006 (deferred loss is taken into account) to ILM 201025046, ILM 200931043 and PLR 201014002 (deferred loss remains deferred) • Note – in consolidation, the liquidation would be tax free. Reg. § 1.1502-34 • P’s loss on the 79 percent of S1? See Commissioner v. Day & Zimmerman, Inc. 151 F.2d 517 (3rd Cir. 1945); Granite Trust Co. v. U.S., 238 F.2d 670 (1st Cir. 1956) • Consider “upstream C” risk
Unified Loss Rules • Basis redetermination rule: • Reg. § 1.1502-36(b); • Adjusts stock basis to prevent the investment adjustment system from creating noneconomic loss and failing to eliminate duplicated loss. • Basis reduction rule: • Reg. § 1.1502-36(c); • Reduces stock basis to prevent noneconomic losses. • Attribute reduction rule: • Reg. § 1.1502-36(d); • Reduces attributes to prevent the duplication of a loss recognized on, or preserved in the basis of, transferred stock.
Unified Loss Rules • Basis redetermination rule: • Has no effect on the overall gain or loss on members' basis in subsidiary stock (e.g., the aggregate basis in all shares remains unchanged, just reallocated). • Positive investment adjustments eliminated from the basis of transferred loss shares (but not below value). • Negative investment adjustments may be removed from shares that are not transferred and applied to reduce the loss on the transferred loss shares. • Adjustments are generally reallocated and applied: • First to increase (but not above value) members’ bases in subsidiary preferred shares. • Second, remaining adjustments are allocated to members’ common stock.
Unified Loss RulesBasis redetermination rule • Basis redetermination rule does not apply if: • There is no disparity among members’ bases in subsidiary common stock, and no member owns a share of subsidiary’s preferred stock with unrecognized gain or loss; or • All subsidiary shares held by members are transferred to non-member(s), become worthless under section 165, or a combination thereof, in one fully taxable transaction. • Parent may still elect to apply the basis redetermination rule.
Unified Loss RulesBasis redetermination rule -Example • P owns Asset A (basis $80, value $80) and Asset B (basis $5, value $5); • P transfers Asset A in exchange for four shares of S common stock (basis $20/share); • When Asset A has declined in value to $20, P transfers Asset B in exchange for one share of S common stock (basis $5/share); • S sells Asset A for $20; the basis of each share of S is reduced by $12; • P sells a share of stock with an $8 basis for $5; • Reallocate negative basis adjustment ($3 of a total of $48) made to the non-transferred shares and apply to the transferred loss share; • Negative basis comes entirely from share with $5 original basis. P Asset A and Asset B S
Unified Loss Rules • Basis reduction rule: • Intended to eliminate stock loss that is presumed noneconomic; • Only applies if, after the application of the basis redetermination rule, the transferred share is still a loss share; • Does not reduce the basis of a transferred share below value.
Unified Loss Rules Basis Reduction Rule • Amount of the basis reduction is the lesser of: • The share’s “net positive adjustment” and • The “disconformity amount.” • Net positive adjustment is the greater of: • Zero and • The sum of the stock basis adjustments, other than reductions for distributions, reflected in the basis of the transferred share. • Disconformity amount is the excess, if any, of • The basis in the transferred share over • The share’s allocable portion of the subsidiary’s net inside attribute amount. • Net inside attribute amount is generally the sum of the subsidiary’s NOLs and capital loss carryovers, deferred deductions, money, and basis in assets other than money, reduced by the amount of the subsidiary’s liabilities.
Unified Loss Rules Basis reduction rule – Lower Tiers • When subsidiary being disposed of owns lower-tier subsidiary and the lower-tier subsidiary is not being transferred in the same transaction: • To determine the disconformity amount: • Basis in the lower tier subsidiary may be treated as reduced by a tentative reduction amount. • The tentative reduction amount is the lesser of the lower-tier subsidiary’s net positive adjustment and disconformity amount. • In case of multiple tiers of nontransferred lower tier subsidiaries: • Generally rules first apply to determine the tentatively reduced basis of stock of the subsidiary at the lowest tier. Then apply at each tier moving up the tiers. • The tentative reductions are treated as noncapital, nondeductible expenses that tier up under the principles of Reg. § 1.1502-32.
Unified Loss Rules Basis reduction rule - Example P Original Asset Basis Value 50 100 PIA 50 Discon. 150-(100+20)=30 S NOL 20 • P purchases S for $100 and they file a C/R, S has $20 NOL carryover (not absorbed in the C/R throughout the transactions here); • S sells the asset for $100 while a member of the P group; • This increases P’s basis in the S stock to $150; • P sells the stock of S for $100 and sustains a $50 loss; • P’s basis in the S stock is reduced by $30 immediately before sale.
Unified Loss Rules • Attribute reduction rule: • Prevent group from recognizing more than one loss with respect to a single economic loss. • If there is a stock loss that reflects a subsidiary’s tax attributes, • The stock loss is allowed, but • The subsidiary is required to reduce its tax attributes; • Election available to reduce stock basis or reattribute certain attributes. • Rule does not apply if aggregate attribute reduction is less than 5 percent of the aggregate value of the transferred shares.
Unified Loss Rules Attribute Reduction Rule • The attribute reduction is limited to the lesser of • The net stock loss; and • The aggregate inside loss. • The net stock loss is • The excess, if any, of the aggregate basis of all shares of the subsidiary’s stock transferred by members in the transaction over the value of those shares. • The aggregate inside loss, with adjustments for lower-tier subsidiaries, is • The excess, if any, of the subsidiary’s net inside attribute amount over the value of all outstanding shares of subsidiary stock. • Net attribute amount is the same as in the basis reduction rule.
Unified Loss Rules Attribute Reduction Rule • If attribute reduction is required, the reduction is generally made by category of attribute: • Capital loss carryovers; • Net operating loss carryovers; • Deferred deductions; • Basis of assets other than, generally, cash and general deposit accounts. • Special rules apply if the subsidiary owns a lower-tier subsidiary. • A favorable reattribution election is available: • The election permits a reduction in members’ bases in transferred loss shares of the subsidiary, or a reattribution of the subsidiary’s attributes other than basis to the extent such attributes would otherwise be subject to a reduction. • Election is only available if the subsidiary ceases to be a member of the selling consolidated group as a result of the transaction.
Unified Loss Rules Attribute Reduction Rule • If the total amount of attribute reduction is lower than the attributes available, the taxpayer can elect which attributes to reduce. • If no election is made, the attributes will be reduced by category beginning with capital loss carryovers. • Within a category, losses are reduced based on vintage. • Other reductions are generally reduced proportionally within the category. • If the total amount of attribute reduction is higher than the attributes available, the remaining reduction amount is suspended to the extent of any liabilities of the subsidiary (or a lower-tier subsidiary) that have not been taken into account for tax purposes before the transfer. • The suspended amount is applied to reduce any amount that would be deductible or capitalizable as a result of the liability later being taken into account. • If the amount of the required attribute reduction exceeds the subsidiary’s liability, the excess is “black hole.”
Unified Loss Rules Attribute reduction rule - Example P Asset Basis Value 100 100 NOL 120 S • P owns 100 shares of S (basis $2/share); • P sells 30 shares of S for $30; • P reduces attributes by lesser: • Net stock loss - $100; • Aggregate inside loss - $120; • S reduces its NOL by $100.
Unified Loss Rules Anti-Abuse Rule • Reg. § 1.1502-36(g) • “If a taxpayer acts with a view to avoid the purposes of this section or to apply the rules of this section to avoid the purposes of any other rule of law, appropriate adjustments will be made to carry out the purposes of this section or such other rule of law.”
Unified Loss RulesEffective Date • The regulations apply to all transfers on or after September 17, 2008, unless the transfer was made pursuant to a binding commitment that was in effect prior to September 17, 2008
Section 1502 and Reg. § 1.1502-47 • If one corporation acquires 80% of the vote and value of target (other than a life insurance company target), target can join in an existing consolidated group. • If 80% of the vote and value of a life insurance company target is acquired, target must wait five years before joining an existing life/nonlife group, unless tacking rules of Reg. § 1.1502-47(d)(12) apply. It can immediately join an existing life/life group. • Query whether and to what extent reinsurance can be utilized to move the life insurance business into the existing life/nonlife group. 48
Section 1504(a)(3) In general, if a corporation is included in a consolidated return and ceases to be a member of the consolidated group, then Such corporation (and any successor corporation) may not be included in the consolidated return (or another consolidated return with the same common parent or a successor of such common parent) for 60 months May reaffiliate sooner if permission is obtained from the Service In many cases, permission is automatically granted pursuant to Rev. Proc. 2002-32 if certain representations can be made The disaffiliation and subsequent consolidation has not provided and will not provide a benefit of a reduction in income, increase in loss, or any other deduction, credit, or allowance (a federal tax savings) that would not otherwise be secured or have been secured had the disaffiliation and subsequent consolidation not occurred Takes into account the net tax consequences to all parties as well as the time value of money
PLR 201002015, 201002016, 201002017 Pre-Date 1 Date 1 Parent Parent Corp A life Sub Sub Corp B life Corp C <80% Sub 1 80% Sub 1 Corp D Sub 3 life Sub 3 life Sub 2 Corp A life Sub 2 Sub 4 life Sub 4 life • Prior to Date 1: • Parent, Sub, Sub 1, Sub 2, Sub 3, and Sub 4 were members of a life/nonlife consolidated group (“Parent Group”) • Corp A, Corp B, Corp C, and Corp D were members of a life/nonlife consolidated group (“Corp A Group”) • On Date 1: • Sub 1 acquired Corp A in exchange for Sub 1 stock, causing Sub 1, Sub 2, Sub 3, and Sub 4 to deconsolidate from Parent Group Corp B life Corp C Corp D