Lawrence M' AxelrodMichelle Estrada IRS Office of Chief Counsel PricewaterhouseCoopers LLP Washingto

1
Lawrence M. Axelrod Michelle EstradaIRS
Office of Chief Counsel PricewaterhouseCoopers
LLPWashington, D.C. Boston, MAPhilip J.
Levine Anthony PicchioneMcDermott Will Emery
LLP WilmerHaleWashington, D.C. Boston,
MAJeffrey L. Vogel KPMG LLP Washington,
D.C.
Current Developments in Consolidated Returns
May 8, 2009 IRS Circular 230 DisclosureTo
ensure compliance with requirements imposed by
the IRS, we inform you that any U.S. federal tax
advice contained in this communication (including
any attachments) is not intended or written to be
used, and cannot be used, for the purpose of (i)
avoiding penalties under the Internal Revenue
Code or applicable state or local tax law
provisions or (ii) promoting, marketing or
recommending to another party any transaction or
matter addressed herein.
2

• 2009 Proposed Basis Regulations
• REG-143686-07

3
2009 Proposed Basis Regulations Current law

• Treasury Regulations 1.302-2(c)
• In any case in which an amount received in
  redemption of stock is treated as a distribution
  of a dividend, proper adjustment of the basis of
  the remaining stock will be made with respect to
  the stock redeemed.
• Treasury Regulations 1.1502-13(f)(7), ex. 3
• Under -13(f)(3), P is treated as receiving
  additional B stock with a fair market value of
  500 and, under section 358, a basis of 250.
  Immediately after the merger, 150 of the stock
  received is treated as redeemed, and the
  redemption is treated under section 302(d) as a
  distribution to which section 301 applies.
  Because the 150 distribution is treated as not
  received as part of the merger, section 356 does
  not apply and no basis adjustments are required
  under section 358(a)(1)(A) and (B). Under -32,
  the 150 distribution reduces the basis of all of
  the B stock held by P (including the stock deemed
  issued in the merger).
• Under 1.302-2(c), proper adjustments are made to
  P's basis in its B stock to reflect its basis in
  the B stock redeemed, with the result that P's
  basis in its remaining B stock is reduced by the
  entire 150 distribution. Post-transaction, P
  holds shares of B with a FMV of 850 and an
  adjusted basis of 350.

P
Cash 150 B shares 350 FMV
AB 250 FMV 500
AB 250 FMV 500
368(a)(1)(A) Merger
S
B
4
2009 Proposed Basis Regulations Redemptions of
ELA shares under current law
PLR 9815050

• P, A, B, and C are members of a
• consolidated group.
• C redeems all of B's C stock for cash.
• The redemption of C stock was
• characterized as a distribution of
• property to which section 301
• applies.
• Citing Treas. Reg. 1.302-2 and
• 1.1502-32, the ruling held that A's basis
• in C will be decreased by the amount by
• which the distribution exceeds B's basis
• in C.
• B does not recognize income in the
• transaction.

A
B
C
Cash
100 of B's C Stock
5
2009 Proposed Basis Regulations 2002 Proposed
Regulations (REG-150313-01)

• On October 17, 2002, the IRS issued proposed
  regulations on redemptions taxable as dividends
  (the 2002 Proposed Regulations). Under the
  2002 Proposed Regulations
• Treas. Regs. 1.302-2(c) is removed.
• 2002 Prop. Treas. Regs. 1.302-5 provided
  that In any case in which an amount received in
  redemption of stock is treated as a distribution
  of a dividend (a dividend equivalent
  redemption), an amount equal to the basis of the
  redeemed stock, after adjusting such basis to
  reflect the application of any applicable
  provision of the Code or Regulations (including
  1.1502-32), is treated as a loss recognized on a
  disposition of the redeemed stock on the date of
  the redemption. Where an amount received in
  redemption of stock is treated as a dividend and
  such amount either increases or creates an excess
  loss account in the redeemed stock, see
  1.1502-19(b)(5).
• Under 2002 Prop. Treas. Regs. 1.1502-19(b)(5),
  such excess loss account is treated as income
  (ordinary income or gain) recognized on
  disposition of the redeemed stock on the date of
  the redemption and, it was proposed that such
  income would be taken into account on the first
  date on which the redeemed shareholder would
  satisfy the criteria of section 302(b)(1), (2),
  or (3) if the facts and circumstances that exist
  at the end of such day had existed immediately
  after the redemption or such earlier date on
  which the redeemed shareholder is permitted to
  take into account a loss recognized on a
  disposition of the stock of the redeemed
  corporation (but only to the extent of such
  loss).

6
2009 Proposed Basis Regulations Public Comments
to 2002 Proposed Regs

• Public comments to the 2002 Proposed Regulations
  made by the ABA Section of Taxation, Committee on
  Corporate Tax
• The effect of the changes is that the income
  attributable to an ELA on the date of a
  redemption within a consolidated group is fixed
  and suspended as of that date and, unlike an ELA,
  the suspended income cannot be subsequently
  eliminated.
• Because the 2002 Proposed Regulations fixes the
  amount and the location of the suspended income,
  in certain circumstances where there is a
  subsequent sale of the stock of a member and a
  Section 338(h)(10) election, there could be
  duplication of gain that would not have occurred
  under the current law.

7
2009 Proposed Basis Regulations Overview

• Under the 2009 Proposed Basis Regulations
• Treas. Regs. 1.302-2(c) is removed and
  reserved.
• New Prop. Treas. Regs. 1.302-5 provides as
  follows
• a dividend equivalent redemption is treated as a
  pro-rata distribution with respect to all shares
  of stock, in the class of shares that includes
  the redeemed shares, held by the shareholder
  immediately before the redemption the portion of
  the distribution that is not a dividend shall
  reduce the basis of each share held by the
  redeemed shareholder, pro rata, on a
  share-by-share basis.
• if less than all of the shares of a class of
  stock held by the taxpayer are redeemed, then
  after the deemed distribution the taxpayer is
  deemed to exchange all of its shares in the
  class, including the redeemed shares, for the
  actual number of shares directly held after the
  redemption in a recapitalization transaction to
  which the tracing rules of the 358 regulations
  apply.
• if all of the shares of a class of stock held by
  the taxpayer are redeemed, then (unlike under the
  current regulations under 302, where any
  unrecovered basis shifts to other shares in
  certain circumstances) the unrecovered basis is
  treated as a deferred loss that is taken into
  account by the taxpayer on the date when the
  conditions of 302(b)(1), (2) or (3) are
  satisfied, or alternatively, when all of the
  shares of the issuing corporation become
  worthless (the "inclusion date").
• The 2009 Proposed Basis Regulations, unlike the
  2002 Proposed Regulations, do not include
  proposed changes to the consolidated return
  regulationsyet.

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2009 Proposed Basis Regulations Comparison to
current law
Treas. Regs. 1.302-2(c), ex. 2
Prop. Treas. Regs. 1.302-5(e), ex. 2

318 attribution
318 attribution
Aggregate Qty. AB
H Block 1 25 0 H Block 2 25
50 W Shares 50 50
Aggregate Qty. AB
H Shares 50 50 W Shares 50
50
H
H
W
W
100
40
100 of Hs X stock
X 100 EP
100 of Hs X stock
X 0 EP

• The facts are similar to Treas. Regs.
  1.302-2(c), ex. 2, except (i) on the date of the
  redemption H holds 2 blocks of stock with
  different bases, (ii) X redeems all of Hs shares
  for 40 and (iii) X has no current or accumulated
  EP on the redemption date.
• Result H has gain of 20 on his Block 1 shares
  and a 30 loss on his Block 2 shares, deferred
  under Prop. Regs. 1.302-5(a)(3) until an
  inclusion date. Ws basis in the remaining stock
  of X is unaffected by the redemption.

• In year 1, Husband (H) purchases 100 shares of
  
• X common stock for 100.
• In year 2, H transfers 50 shares to Wife (W).
• In year 3, X redeems all of Hs shares for 100.
• Result H has dividend income of 100.
  Immediately after the redemption, W holds the
  remaining stock of X with a basis of 100.

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2009 Proposed Basis Regulations Preamble

Preamble to the 2009 Proposed Basis
Regulations The IRS and Treasury Department
continue to study the issues raised when a
redeemed shareholder with a deferred loss files a
consolidated return. The IRS and Treasury
Department believe that certain of the concerns
raised by REG-150313-01 are addressed in these
proposed regulations by the deemed
recapitalization mechanic described in section
II.B.i. of this Preamble. ? Presumably
certain of the concerns refers only to the case
in which, following a redemption by a
consolidated group member, the
redeemed member continues to directly hold some
shares of the same class of stock of
the redeeming member following the
redemption.
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2009 Proposed Basis Regulations Changed Results?
P
PLR 200810015
A
C
B
100 of Bs C stock
Cash

• Rulings (under current law)
• The redemption of Bs C stock was characterized
  as a distribution of property to which section
  301 applies.
• Citing Treas. Reg. 1.302-2(c)(2),
• the ruling held that B's post redemption basis or
  ELA will shift to P's C stock.
• B does not recognize income in the transaction.

• Under the 2009 Proposed Basis Regulations
• Is there a clear answer as to what happens if B
  has an ELA in its C stock on the date of the
  redemption?
• Would Prop. Treas. Regs. 1.302-5(a)(3) apply
  by reason of Treas. Regs. 1.1502-80(a)(1) and
  1.1502-19(a) and create suspended gain?
• Is the IRS looking for additional comments on
  this point?

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GROUP CONTINUATION TRANSACTIONS UNDER 1.1502-75
and PLR 200905001
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Group Continuation General Rule

• A group remains in existence for a tax year if
• the common parent remains as the common parent
  and
• at least one subsidiary that was affiliated with
  it at the end of the prior year remains
  affiliated with it at the beginning of the year.
  1.1502-75(d)(1).
• It does not matter whether one or more
  corporations have ceased to be subsidiaries of
  the common parent at any time after the group was
  formed. Id.

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Group Continuation General Rule -- Example
P
P
7/15/Yr. 3 P sells S
P
2/15/Yr. 3 P acquires S1
P and S consolidate
S
S1
S
S1
Year 3
Year 4
Years 1-2

• Facts P and S file a consolidated return in
  Years 1 and 2. On 2/15/Yr. 3, P acquires all of
  S1s stock. On 7/15/Yr. 3, P sells all of the S
  stock S to a nonmember. P continues to own the
  stock of S1.
• Analysis
• P remains the common parent in Year 4 and
• At least one subsidiary (S1) that was affiliated
  with P at the end of Year 3 remains affiliated
  with P at the beginning of Year 4.
• Result The P consolidated group continues in
  Year 4.
• Note The result is the same if, in Year 3, P
  first sells the S stock to a nonmember and then
  acquires the S1 stock.

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14
Group Continuation Exception for Certain
Downstream Transactions (1.1502-75(d)(2)(ii))

• The group shall be considered as remaining in
  existence notwithstanding that the common parent
  is no longer in existence if
• the members of the affiliated group succeed to
  and become the owners of substantially all of the
  assets of such former parent and
• there remains one or more chains of includible
  corporations connected through stock ownership
  with a common parent corporation which is an
  includible corporation and which was a member of
  the group prior to the date such former parent
  ceases to exist.

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15
Group Continuation Exception for Certain
Downstream Transactions -- Example
Shs.
Shs.
Result
Transaction
P
S stock
S
Hook stock
S
merge
S1/P
S1

• Facts P owns S, which owns S1. P, S, and S1
  file a consolidated return. P merges into S1,
  with S1 surviving.
• Analysis
• Members of the affiliated group succeed to and
  become the owners of substantially all of Ps
  assets.
• There remains a chain of includible corporations
  connected through stock ownership with an
  includible common parent corporation that was a
  member of the group prior to the date P ceased to
  exist.
• Result The P group remains in existence with S
  as the common parent.

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16
Group Continuation Exception for Reverse
Acquisitions (1.1502-75(d)(3))

• The reverse acquisition exception addresses
  transactions in which the minnow swallows the
  whale.
• The reverse acquisition exception applies if
• (i) a corporation (the 1st corporation)
  acquires stock of another corporation (the 2nd
  corporation) in exchange (in whole or in part)
  for stock of the 1st corporation, and as a result
  the 2nd corporation would otherwise become a
  member of a group of which the 1st corporation is
  the common parent and
• (ii) the stockholders of the 2nd corporation, as
  a result of owning stock of the 2nd corporation,
  own (immediately after the acquisition) more than
  50 of the FMV of the stock of the 1st
  corporation,
• If the reverse acquisition exception applies, the
  1st corporations group ceases to exist and the
  group of which the 2nd corporation was the common
  parent remains in existence, with the 1st
  corporation as the common parent.
• The reverse acquisition exception similarly
  applies if the 1st corporation acquires
  substantially all of the assets of the 2nd
  corporation.

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17
Group Continuation Exception for Reverse
Acquisitions -- Example
P2 Shs.
P1 Shs.
P1 Shs.
Transaction
P2 Shs.
Result
60 P1 stock
60
40
P2 stock
P1
P1 (V40)
P2 (V60)
S1
P2
S1
S2
S2

• Facts P1 (value40) is the parent of a
  consolidated group that includes S1. P2
  (value60) is the parent of a separate
  consolidated group that includes S2. P1 acquires
  all of the stock of P2 in exchange for 60 of
  P1s stock.
• Analysis The transaction is a reverse
  acquisition because
• P1 acquires P2 stock in exchange for P1 stock.
• But for the reverse acquisition exception, P2
  would become a member of the P1 group.
• The P2 shareholders, by reason of owning P2
  stock, own more than 50 of the FMV of the stock
  of P1.
• Result
• The P2 group continues, with P1 as the common
  parent.
• The P1 group terminates.

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18
Group Continuation Rev. Rul. 82-152
Shs.
Shs.
Result
Transaction
P
S
S stock
S
P/T
merge
T

• Facts P owns S, which owns T. P, S, and T
  filed a consolidated return. T merges into P,
  with P surviving the former P shareholders
  exchange all of their P stock for S stock. The S
  stock owned by P is cancelled.
• The Rulings Analysis
• The transaction does not satisfy the literal
  description of either a -75(d)(2)(ii) downstream
  transaction or a -75(d)(3) reverse acquisition
  because
• -75(d)(2)(ii) describes only transactions in
  which P ceases to exist.
• -75(d)(3) describes the acquiring corporation as
  a common parent, and therefore the acquiring
  corporation cannot be an affiliated subsidiary of
  the acquired corporation. But see
  1.1502-75(d)(3)(iv).
• However, the transaction is indistinguishable in
  substance from a -75(d)(2)(ii) transaction.
  Thus, the transaction should not result in a
  termination of the P group.
• Result The P group continues.

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19
Group Continuation PLR 200905001 (simplified)
Public
Public
Public
Holding Company Transaction
Result
Spin-off
Newco (US)
D (f)
Newco (US)
merge
D (f)
C (US)
Newco (US)
D (f)
C (US)
Spin-off
C (US)
Subs (US)
Merger Sub
Subs (US)
Subs (US)

• Facts D, a publicly traded foreign corporation,
  owns all of the stock of C, a US corporation. C
  is the parent of a consolidated group that
  includes Subs. Two sets of transactions occur.
  First, D forms Newco, which forms Merger Sub.
  Merger Sub merges into D, with D surviving. The
  public ends up owning the stock of Newco, which
  owns D (the Holding Company Transaction). The
  ruling concludes that the Holding Company
  Transaction qualifies as a B reorganization.
  Second, D distributes the stock of C to Newco pro
  rata (the Spin-off). The ruling concludes that
  the Spin-off qualifies under section 355.
• The PLRs Consolidated Return Rulings
• The C consolidated group remains in existence,
  with Newco becoming the common parent (citing
  Rev. Rul. 82-152).
• The transactions qualify as a group structure
  change for purposes of 1.1502-31 and -33.
  Newcos basis in the C stock immediately after
  the Spin-off is Cs net asset basis as determined
  under 1.1502-31(c) and (d), notwithstanding the
  basis allocation required by 1.358-2(a)(2).

19
20
Group Continuation PLR 200905001 (simplified)
(continued)

• Analysis of the Group Continuation Ruling
• The Spin-off causes Newco to become the common
  parent. Absent an exception, this should cause
  the C group to terminate.
• Is the transaction described in -75(d)(2)(ii) (as
  expanded by Rev. Rul. 82-152)?
• C does not cease to exist (as required by
  -75(d)(2)(ii)).
• Newco, the new common parent, is not a member of
  the C group before the transactions (as
  apparently required by -75(d)(2)(ii) and as in
  Rev. Rul. 82-152).
• The Spin-off is an upstream transaction, not a
  downstream transaction (unlike -75(d)(2)(ii) and
  Rev. Rul. 82-152).
• Is the Spin-off indistinguishable in substance
  from a -75(d)(2)(ii) transaction?
• Is the transaction described in -75(d)(3)
  (reverse acquisitions)?
• Newco does not acquire C in exchange for Newco
  stock (as required by -75(d)(3)).
• The ruling does not refer to the respective
  values of D and C.

20
21
Group Continuation PLR 200905001 (simplified)
(continued)

• Related Questions
• What if in the ruling Newco were an old-and-cold
  includible corporation that owned the stock of D?
• What if in the ruling Newco had other assets?
• What if a foreign corporation (FC) forms a US
  includible corporation (Newco), contributes cash
  to Newco, and Newco then purchases the stock of a
  consolidated group parent (P)?
• Does the P group terminate, since P ceases to be
  the common parent? Or does the P group continue
  with Newco as the common parent?
• Note that if FC had purchased P and then dropped
  P to Newco in exchange for Newcos stock, the
  drop to Newco presumably would have been a
  reverse acquisition (assuming that the value of P
  exceeded the value of Newcos other assets, if
  any).
• Does Rev. Rul. 82-152 apply, so that FC can use a
  newly formed US corporation to acquire P without
  terminating the P group?

22
Group Continuation PLR 200905001 (simplified)
(continued)

• Analysis of the Net Asset Basis Ruling
• 1.1502-31(b)(2) provides If a corporation
  acquires stock of the former common parent in a
  group structure change, the basis of the members
  in the former common parents stock immediately
  after the group structure change that is, or
  would otherwise be, transferred basis property is
  redetermined in accordance with the results for
  an asset acquisition described in paragraph
  (b)(1) of this section.
• Was Cs stock transferred basis property?

23
CCA 200901031
24
CCA 200901031
Year 1 Year 5 Year 11
Shs.
Shs.
Shs.
Shs.
Shs.
P
S
P
S
P
merger
S
P
S
(10)
(60)
T
T

• Assume the Following Facts
• In Year 1, the P, S, and T consolidated group
  is formed (the P Group).
• On 1/1 of Year 5, a Rev. Rul. 82-152
  transaction occurs (merger of T into P with P
  surviving) such that the former P shareholders
  exchange all of their P stock for S stock, and
  the S stock owned by P is cancelled. The P Group
  does not terminate. P becomes the Former Common
  Parent and S becomes the Actual Common Parent.
  
• In Years 5 10, the P Group is profitable
  solely due to taxable income generated by S.
• On 12/31 of Year 10, the P Group terminates.
• In Year 11, P generates a separate return 10
  loss and S generates a separate return 60 loss.
• Issue
• Whether P, the Former Common Parent, is the
  Lonely Parent for purposes of carrying back NOLs
  to post-acquisition years of the historic group?
  
• Conclusion
• The Actual Common Parent, and not the Former
  Common Parent, is the Lonely Parent for purposes
  of carrying back NOLs to Years 5-10. Therefore,
  P cannot carryback its 10 loss to the historic
  group without a SRLY limitation.

25
CCA 200901031 Observations

• The government took a similar position with
  respect to a reverse acquisition followed by the
  termination of a consolidated group in CCA
  200441026 (June 25, 2004).
• This issue is more likely to arise with respect
  to specified liability losses (SLLs), which
  can be carried back for a period of 10 years
  under section 172(f).

26
Relevant Law

• SRY
• Treas. Reg. 1.1502-1(e) defines a separate
  return year (SRY) as a taxable year of a
  corporation for which it files a separate return
  or for which it joins in the filing of a
  consolidated return by another group.
• SRLY
• Treas. Reg. 1.1502-1(f)(1) defines a separate
  return limitation year (SRLY) as any SRY of a
  member or of a predecessor of a member except as
  provided in Treas. Reg. 1.1502-1(f)(2) and (3).
• Exception The Lonely Parent Rule (Treas. Reg.
  1.1502-1(f)(2)(i))
• SRLY does not include, among other things, a SRY
  of the corporation which is the common parent for
  the consolidated return year to which the tax
  attribute is to be carried (except as provided in
  Treas. Reg. 1.1502-75(d)(2)(ii) and
  1.1502-1(f)(3)) .

27
Relevant Law

• Treas. Reg. 1.1502-75(d)(2)(ii)
• A consolidated group does not terminate
  notwithstanding that the common parent is no
  longer in existence if the members of the former
  parents affiliated group succeed to and become
  the owners of substantially all of the assets of
  such former parent and there remains one or more
  chains of includible corporations connected
  through stock ownership with a common parent
  corporation which is an includible corporation
  and which was a member of the group prior to the
  date such former parent ceases to exist.
• In addition, this rule provides that for purposes
  of applying the Lonely Parent Rule to SRYs ending
  on or before the date on which the former parent
  ceases to exist, such former parent, and not the
  new common parent, shall be considered to be the
  corporation described in the Lonely Parent Rule
  (i.e., Treas. Reg. 1.1502-1(f)(2)(i)) (the
  Lonely Parent Reversal Rule).

28
Relevant Law

• Treas. Reg. 1.1502-1(f)(3)
• In the event of an acquisition to which Treas.
  Reg. 1.1502-75(d)(3) applies, all taxable years
  of the first corporation and of each of its
  subsidiaries ending on or before the date of the
  acquisition shall be treated as separate return
  limitation years, and the separate return years
  (if any) of the second corporation and each of
  its subsidiaries shall not be treated as separate
  return limitation years (unless they were so
  treated immediately before the acquisition).

29
CCAs 200901031 and 200441026 Related Questions
Year 1
Years 2-3
Year 5
Lonely Parent
Lonely Parent
A
A
A
NOL
NOL
B
B
B
NOL
NOL
SRLY
SRLY

• In Year 4, A sells B to unrelated parties and the
  group terminates.
• In Year 5, A and B each generate a loss.

• A and B are separate filers.
• A and B generate a loss.

• In Year 2, A acquires B in a transaction that is
  not a reverse acquisition.
• A and B file a consolidated return.

Year 1
Years 2-3
Year 5
Non- SRLY
SRLY
A
B
A
NOL
NOL
B
A
B
NOL
NOL
SRLY
Lonely Parent

• Same facts as above, except that in Year 2, B
  acquires A in a reverse acquisition, and in Year
  4, B sells the stock of A to unrelated parties.
• Why is there a different lonely parent for
  carryback purposes if the substance of these two
  transactions is the same?

30
CCA 200901031

• Taxpayers Arguments (representing P)
• Tax Policy Argument
• The Former Common Parent should be entitled to
  Lonely Parent status with regard to carrybacks to
  post-acquisition years of the historic group
  because of the similarity of a RR 82-152
  transaction to a Treas. Reg. 1.1502-75(d)(2)(ii)
  transaction.
• Consistency Argument
• The Lonely Parent Rule does not distinguish
  between carryforwards and carrybacks, so there is
  a basic requirement that the same corporation
  must be the Lonely Parent for purposes of loss
  carryforwards and loss carrybacks.
• Gottesman Argument
• Since Treasury and the Service have not
  specifically addressed the application of the
  Lonely Parent Rule to RR 82-152 transactions, the
  Taxpayer is entitled to reasonably apply whatever
  guidance is available. See Gottesman v. Commr.,
  77 T.C.1149 (1981).

31
CCA 200901031

• Governments Rebuttals
• Literal Reading of Regulation
• The -75(d)(2)(ii) exception to the Lonely Parent
  Rule applies only with regard to loss
  carryforwards to post-acquisition years because
  the common parent ceases to exist. Therefore,
  even if the Lonely Parent Reversal Rule applied
  in the context of a RR 82-152 transaction, it
  would not provide relief to P.
• Tax Policy Argument
• To accept the taxpayers position would lead to a
  double Lonely Parent in the same carryback year
  (1) the Former Common Parent under the policy
  argument and (2) the Actual Common Parent under
  the literal reading of the regulation.
• Under the taxpayers approach, any case in which
  the historic group continues for an extended
  period of time following the Former Common
  Parents disaffiliation, the group would be
  denied any benefit of the Lonely Parent Rule for
  carrybacks to post-acquisition years.

32
CCA 200901031

• Governments Rebuttals
• Consistency Argument
• The regulation does, in fact, distinguish between
  carryforwards and carrybacks (see underlined text
  in Relevant Law section). There is no instance
  in which the regulations (including the reverse
  acquisition regulations) ever grant Lonely Parent
  status with regard to carrybacks to any entity
  other than the Actual Common Parent.
• Gottesman Argument
• This is not applicable because there is a
  regulation on point that addresses the issue.

33

• Donald L. Russell, et ux. v. Commissioner,
• T.C. Memo 2009-29 (Feb. 9, 2009)

34
Russell v. Commr Facts
1
2
K
R
K
R
117,438
65,527
50
50
UEC consolidated group
UEC
MRRC (S Corp.) -117,438 K -65,527 R
RGC
MRRC -117,438 K -65,527 R
REMC

• On September 1, 1997 R and K each contributed
  the shares in MRRC (along with shares each held
  in RGC and REMC) to UEC in exchange for UEC
  shares in a transaction qualifying as tax free
  under Section 351.
• As a result of the transaction, the MRRC
  taxable year ended on August 31, 1997. Under
  Section 1367(b)(2), as a result of losses
  allocable to each of R and K for the tax year
  ended August 31, 1997, Rs basis in the R Ledger
  Debt and Ks basis in the K Ledger Debt was
  reduced below their respective fair market
  values.

• R and K are the only shareholders of MRRC, an S
  Corp.
• R and K each made a loan to MRRC, (the Ledger
  Debt).
• As of September 1, 1997 the principal balance
  and the
• FMV of the K Ledger Debt was 117,438 and the
• principal balance and FMV of the R Ledger Debt
  was
• 65,527.

35
Russell v. Commr Issue

• ? Whether the Ledger Debt was deemed satisfied
  and reissued before or after contribution to UEC.

• Taxpayer UEC realized no gain from the R
  Ledger Debt and the K Ledger Debt by virtue of
  section 1.1502-13(g)(5), Example (2), Proposed
  Income Tax Regs., 63 Fed. Reg. 70356 (Dec. 21,
  1998).
• Query why the Taxpayer was relying on an example
  that involved the transfer of an intercompany
  obligation from one member to another.

• IRS -13(g)(4) (currently -13(g)(5)) applies.
  As a result, the Ledger Debt is deemed satisfied
  and reissued for the FMV of the Ledger Debt,
  immediately after the 351 transaction. As a
  result, UEC recognized gain immediately following
  the contribution of the R Ledger Debt and the K
  Ledger Debt to the extent that the value of each
  debt exceeded its basis.

36
Russell v. Commr Result
The Tax Court sided with the IRS, holding that
the Ledger Debt was a non-intercompany obligation
that became an intercompany obligation in the 351
exchange. Accordingly, immediately following the
351 exchange, the Ledger Debt was deemed
satisfied for its fair market value. UEC
recognized gain on the deemed satisfaction to the
extent that the fair market value of the Ledger
Debt exceeded UECs basis.