[Federal Register: July 18, 2003 (Volume 68, Number 138)]
[Rules and Regulations]
[Page 42590-42593]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18jy03-15]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9080]
RIN 1545-BC47
Reduction of Tax Attributes Due to Discharge of Indebtedness
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains regulations relating to the reduction
of tax attributes under sections 108 and 1017 of the Internal Revenue
Code. These temporary regulations affect taxpayers that exclude
discharge of indebtedness income from gross income under section 108.
The text of the temporary regulations also serves as the text of the
proposed regulations set forth in the notice of proposed rulemaking on
this subject in the Proposed Rules section in this issue of the Federal
Register.
DATES: Effective Date: These temporary regulations are effective July
17, 2003.
Applicability Date: These temporary regulations apply to discharges
of indebtedness occurring after July 17, 2003.
FOR FURTHER INFORMATION CONTACT: Theresa M. Kolish (202) 622-7930 of
the Office of the Associate Chief Counsel (Corporate) (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Background
The Debt Discharge Rules
Pursuant to section 61(a)(12), gross income includes income from
the discharge of indebtedness (COD income). Section 108(a)(1), which
reflects the amendments enacted in the Bankruptcy Tax Act of 1980,
Public Law 96-589, section 2, 94 Stat. 3389 (1980) (1980-2 C.B. 607),
however, provides that, where the discharge occurs in a title 11 case,
where the taxpayer is insolvent, or where the indebtedness is
``qualified farm indebtedness'' or ``qualified real property business
indebtedness,'' gross income does not include any amount that otherwise
would be includible in gross income by reason of that discharge (in
whole or in part) of the indebtedness of the taxpayer.
Although section 108(a) excludes COD income from gross income under
those circumstances, section 108(b) requires the reduction of certain
tax attributes in an amount that reflects the amount excluded from
gross income, thereby generally deferring, rather than permanently
eliminating, the inclusion of COD income. Section 108(b)(2) requires
the reduction of the following tax attributes of the taxpayer in the
following order: (A) Net operating losses; (B) general business
credits; (C) minimum tax credits; (D) capital loss carryovers; (E)
adjusted basis of property; (F) passive activity losses and credit
carryovers; and (G) foreign tax credit carryovers. Section 108(b)(4)(A)
provides that the reductions are made after the determination of the
tax imposed for the taxable year of the discharge. Section 108(b)(4)(B)
provides that the reductions of net operating losses and capital loss
carryovers are made first in the loss for the taxable year of the
discharge and then in the carryovers to such taxable year in the order
of the taxable years from which each such carryover arose. If the
excluded COD income exceeds the sum of the taxpayer's tax attributes,
the excess is disregarded such that it does not result in income or
have other tax consequences. See H.R. Rep. No. 96-833, at 11 (1980).
Instead of reducing tax attributes in the order set forth in
section 108(b)(2), a taxpayer may elect under section 108(b)(5) to
reduce first the adjusted bases of depreciable property to the extent
of the excluded COD income. The amount to which the election applies is
limited to the aggregate adjusted basis of the depreciable property
held by the taxpayer as of the beginning of the taxable year following
the taxable year in which the discharge occurs. If the adjusted bases
of depreciable property are insufficient to offset the entire amount of
excluded COD income, the taxpayer must then reduce any remaining tax
attributes in the order set forth in section 108(b)(2). Congress
intended the election under section 108(b)(5) to allow debtors,
including debtors in bankruptcy, to account for a debt discharge amount
in a manner most favorable to their tax situations. See S. Rep. No. 96-
1035, at 10 (1980); H.R. Rep. No. 96-833, at 9 (1980).
Section 1017(a) provides that when any portion of COD income
excluded from gross income under section 108(a) is to be applied to
reduce basis, then such portion shall be applied to reduce the basis of
any property held by the taxpayer at the beginning of the taxable year
following the taxable year in which the discharge occurs. Section
1017(b)(1) provides that the amount of reduction under section 1017(a),
and the particular properties the bases of which
[[Page 42591]]
are to be reduced, shall be determined under regulations.
The Reorganization Rules
Section 368(a)(1) defines a reorganization to include certain types
of asset acquisitions. Under section 361, a corporation that is a party
to a reorganization recognizes neither gain nor loss when it exchanges
property, in pursuance of the plan of reorganization, solely for stock
or securities in another corporation that is a party to the
reorganization. If the corporation receives in the exchange not only
stock or securities permitted to be received without the recognition of
gain, but also other property or money, then the corporation may be
required to recognize gain. Under section 362(b), if property is
acquired by a corporation in connection with a reorganization, then the
basis is the same as it would be in the hands of the transferor,
increased by the amount of gain recognized to the transferor on such
transfer.
Section 332(a) provides that a corporation recognizes no gain or
loss on the receipt of property distributed in complete liquidation of
another corporation. Section 337(a) provides that a liquidating
corporation recognizes no gain or loss on the distribution to the 80-
percent distributee of any property in a complete liquidation to which
section 332 applies. Under section 334(b)(1), if property is received
by a corporate distributee in a distribution in a complete liquidation
to which section 332 applies, the basis of such property in the hands
of such distributee is the same as it would be in the hands of the
transferor. However, in any case in which gain or loss is recognized by
the liquidating corporation with respect to such property, the basis of
such property in the hands of such distributee is the fair market value
of the property at the time of the distribution.
Section 381 provides that a corporation that acquires the assets of
another corporation in a distribution to which section 332 applies or
in a transfer to which section 361 applies (but only if the transfer is
in connection with certain reorganizations described in sections
368(a)(1)(A), (C), (D), (F), or (G)) shall succeed to, and take into
account, as of the close of the day of distribution or transfer, the
items described in section 381(c) of the distributor or transferor
corporation, subject to certain conditions and limitations. Among those
items described in section 381(c) are net operating loss carryovers,
capital loss carryovers, general business credits, and minimum tax
credits. With respect to net operating loss carryovers and capital loss
carryovers, the regulations under section 381 reflect that the
acquiring corporation succeeds to only those carryovers that remain
after the application of sections 172 and 1212 and their carryforward
and carryback provisions. See Sec. Sec. 1.381(c)(1)-1; 1.381(c)(3)-1.
Furthermore, those regulations provide that the acquiring corporation
succeeds to only those general business credits that remain unused by
the transferor corporation after computing its taxable income for the
year of the transfer. See Sec. 1.381(c)(23)-1. Section 381(b)(1)
provides that, except in the case of an acquisition in connection with
a reorganization described in section 368(a)(1)(F), the taxable year of
the distributor or transferor corporation ends on the date of
distribution or transfer.
Interaction Between Debt Discharge and Reorganization Rules
Questions have arisen regarding the application of the attribute
reduction rules of sections 108 and 1017 when a transaction described
in section 381(a) ends a taxable year in which the transferor excludes
COD income from gross income. If section 108(b)(4)(A) and section 1017
were interpreted to require attribute reduction to occur after the
close of the taxable year of discharge and after the transfer of assets
and carryover of items described in section 381(c), then arguably no
attributes described in section 108(b)(2) would be available for
reduction.
Explanation of Provisions
The IRS and Treasury Department believe that the rule of section
108(b)(4)(A) prescribes an ordering of calculations. First, section
108(b)(4)(A) requires a determination of the taxpayer's tax for the
taxable year of discharge in order to identify the amounts, if any, of
the tax attributes described in section 108(b)(2) that remain available
for reduction. Second, section 108(b)(4)(A) requires the reduction of
those attributes. This ordering rule affords the taxpayer the use of
certain of its tax attributes described in section 108(b)(2), including
any losses carried forward to the taxable year of discharge, for
purposes of determining its tax for the taxable year of discharge,
before subjecting those attributes to reduction.
Similarly, the IRS and Treasury believe that the rule of section
1017 prescribes an ordering of calculations. The Bankruptcy Tax Act of
1980 reflects that Congress enacted the rule of section 1017 ``to avoid
interaction between basis reduction and reduction of other
attributes.'' S. Rep. No. 96-1035, at 14 (1980); H. Rep. No. 96-833, at
11 (1980). Without this rule, a circular calculation could be required.
The taxpayer's net operating loss for the year of the discharge of
indebtedness might be based in part on the amount of cost recovery
deductions allowed to the taxpayer. The amount of cost recovery
deductions, however, would depend on the taxpayer's basis in its
depreciable or amortizable property at the end of the year. Because net
operating losses are reduced by excluded COD income prior to the
reduction of asset basis absent an election under section 108(b)(5),
the amount of basis required to be reduced would depend on the amount
of net operating losses. Reducing the basis of property held by the
taxpayer at the beginning of the taxable year following the taxable
year in which the discharge occurs avoids this circularity.
The position that sections 108 and 1017 require the reduction of
attributes, including the basis of transferred assets, in cases where
the debtor's taxable year ends with a transfer of assets in a
transaction described in section 381 is consistent with the policies
underlying sections 108 and 1017 and the corporate reorganization
provisions, including ``deferring, but eventually collecting within a
reasonable period, tax on ordinary income realized from debt
discharge.'' S. Rep. No. 96-1035, at 10 (1980). For example, assume
that a debt of corporation X is discharged in a title 11 case. X's
attributes described in section 108(b)(2) consist solely of basis in
property. As part of a plan of reorganization, X transfers all of its
assets to a newly formed corporation, Y. Under section 368(a)(3)(C),
even though the transaction also qualifies as a reorganization under
section 368(a)(1)(F), the transaction is treated as qualifying as a
reorganization only under section 368(a)(1)(G). If sections 108 and
1017 were interpreted to not require a reduction of the bases of the
property transferred, X would permanently exclude from gross income the
COD income, notwithstanding that X underwent nothing more than a mere
change in identity, form, or place of organization. Accordingly,
consistent with the legislative history of the Bankruptcy Tax Act of
1980, the IRS and Treasury Department believe that the basis reduction
rules of sections 108 and 1017 apply to property of a debtor
transferred in a transaction described in section 381(a).
The legislative history of the Bankruptcy Tax Act of 1980 reflects
that Congress specifically anticipated that amounts that carry over in
a transaction described in section 381, including the
[[Page 42592]]
basis of transferred property, are to be adjusted under the rules of
sections 108 and 1017 to account for excluded COD income. See H.R. Rep.
No. 96-833, at 32-34 (1980). The legislative history states:
Assume that Corporation A is in a bankruptcy case commenced
after October 1, 1979. Immediately prior to a transfer under a plan
of reorganization, A's assets have an adjusted basis of $75,000 and
a fair market value of $100,000. A has a net operating loss
carryover of $200,000. A has outstanding bonds of $100,000 (on which
there is no accrued but unpaid interest) and trade debts of
$100,000.
Under the plan of reorganization, A is to transfer all its
assets to Corporation B in exchange for $100,000 of B stock.
Corporation A will distribute the stock, in exchange for their
claims against A, one-half to the security holders and one-half to
the trade creditors. A's shareholders will receive nothing.
The transaction would qualify as a reorganization under new
section 368(a)(1)(G) of the Code, since all the creditors are here
treated as proprietors for continuity of interest purposes. Thus, A
would recognize no gain or loss on the transfer of its assets to B
(sec. 361). B's basis in the assets would be $75,000 (sec. 362), and
B would succeed to A's net operating loss carryover (sec. 381).
Under the bill, * * * [o]n the distribution of B stock to A's
trade creditors, A excludes from gross income the debt discharge
amount of $50,000--i.e., the difference between the $100,000 debt
held by non-security creditors and the $50,000 worth of stock given
for such debt. A may elect to reduce the basis of its depreciable
assets transferred to B by all or part of the $50,000 debt discharge
amount; to the extent the election is not made, the debt discharge
amount reduces A's net operating loss carryover by the remainder of
the debt discharge amount.
H.R. Rep. No. 96-833, at 34 (1980). The treatment of the net operating
loss and basis in the legislative history demonstrates that, in a
transaction described in section 381, the transferor's attributes,
including the basis of transferred property, that carry over to the
transferee are reduced.
Accordingly, these temporary regulations clarify that, in the case
of a transaction described in section 381(a) that ends a year in which
the distributor or transferor corporation excludes COD income from
gross income under section 108(a), any tax attributes to which the
acquiring corporation succeeds and the basis of property acquired by
the acquiring corporation in the transaction shall reflect the
reductions required by sections 108 and 1017. For this purpose, all
attributes listed in section 108(b)(2) of the distributor or transferor
corporation immediately prior to the transaction described in section
381(a), including the basis of property, but after the determination of
tax for the year of the discharge, are available for reduction under
section 108(b)(2).
These temporary regulations also clarify that the tax attributes
subject to reduction under section 108(b)(2) that are carryovers to the
taxable year of the discharge, or that may be carried back to taxable
years preceding the year of the discharge, are first taken into account
by the taxpayer for the taxable year of the discharge or the preceding
years, as the case may be, before such attributes are reduced pursuant
to section 108(b)(2).
These temporary regulations apply to discharges of indebtedness
occurring after July 17, 2003.
Special Analyses
It has been determined that these temporary regulations are not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedures Act (5
U.S.C. chapter 5) does not apply to these temporary regulations, and,
because no preceding notice of proposed rulemaking is required for
these temporary regulations, the provisions of the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do not apply. Pursuant to section
7805(f) of the Internal Revenue Code, these temporary regulations will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Drafting Information
The principal author of these temporary regulations is Theresa M.
Kolish, Office of Associate Chief Counsel (Corporate). However, other
personnel from the IRS and Treasury Department participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding the
following entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.108-7T also issued under 26 U.S.C. 108. * * *
0
Par. 2. Section 1.108-7T is added to read as follows:
Sec. 1.108-7T Reduction of attributes (temporary).
(a) In general. (1) If a taxpayer excludes discharge of
indebtedness income (COD income) from gross income under section
108(a)(1)(A), (B), or (C), then the amount excluded shall be applied to
reduce the following tax attributes of the taxpayer in the following
order:
(i) Net operating losses.
(ii) General business credits.
(iii) Minimum tax credits.
(iv) Capital loss carryovers.
(v) Basis of property.
(vi) Passive activity loss and credit carryovers.
(vii) Foreign tax credit carryovers.
(2) The taxpayer may elect under section 108(b)(5), however, to
reduce first the basis of depreciable property to the extent of the
excluded COD income. If the basis of depreciable property is
insufficient to offset the entire amount of the excluded COD income,
the taxpayer must then reduce any remaining tax attributes in the order
specified in section 108(b)(2). If the excluded COD income exceeds the
sum of the taxpayer's tax attributes, the excess is permanently
excluded from the taxpayer's gross income. For rules relating to basis
reductions required by sections 108(b)(2)(E) and 108(b)(5), see
sections 1017 and 1.1017-1. For rules relating to the time and manner
for making an election under section 108(b)(5), see Sec. 1.108-4.
(b) Carryovers and carrybacks. The tax attributes subject to
reduction under section 108(b)(2) and paragraph (a)(1) of this section
that are carryovers to the taxable year of the discharge, or that may
be carried back to taxable years preceding the year of the discharge,
are taken into account by the taxpayer for the taxable year of the
discharge or the preceding years, as the case may be, before such
attributes are reduced pursuant to section 108(b)(2) and paragraph
(a)(1) of this section.
(c) Transactions to which section 381 applies. In the case of a
transaction described in section 381(a) that ends a taxable year in
which the distributor or transferor corporation excludes COD income
under section 108(a), any tax attributes to which the acquiring
corporation succeeds and the basis of property acquired by the
acquiring corporation in the transaction shall reflect the reductions
required by section 108(b). For this purpose, all attributes listed in
section 108(b)(2) of the distributor or transferor corporation
immediately prior to the transaction described in section 381(a), but
after the determination of tax for the year of the discharge, including
basis of property,
[[Page 42593]]
shall be available for reduction under section 108(b)(2).
(d) Examples. The following examples illustrate the application of
this section:
Example 1. (i) Facts. In Year 4, X, a corporation in a title 11
case, is entitled under section 108(a)(1)(A) to exclude from gross
income $100,000 of COD income. For Year 4, X has gross income in the
amount of $50,000. In each of Years 1 and 2, X had no taxable income
or loss. In Year 3, X had a net operating loss of $100,000, the use
of which when carried over to Year 4 is not subject to any
restrictions other than those of section 172.
(ii) Analysis. Pursuant to paragraph (b) of this section, X
takes into account the net operating loss carryover from Year 3 in
computing its taxable income for Year 4 before any portion of the
COD income excluded under section 108(a)(1)(A) is applied to reduce
tax attributes. Thus, the amount of the net operating loss carryover
that is reduced under section 108(b)(2) and paragraph (a) of this
section is $50,000.
Example 2. (i) Facts. The facts are the same as in Example 1,
except that in Year 4 X sustains a net operating loss in the amount
of $100,000. In addition, in each of Years 2 and 3, X reported
taxable income in the amount of $25,000.
(ii) Analysis. Pursuant to paragraph (b) of this section and
section 172, the net operating loss sustained in Year 4 is carried
back to Years 2 and 3 before any portion of the COD income excluded
under section 108(a)(1)(A) is applied to reduce tax attributes.
Thus, the amount of the net operating loss that is reduced under
section 108(b)(2) and paragraph (a) of this section is $50,000.
Example 3. (i) Facts. In Year 2, X, a corporation in a title 11
case, has outstanding trade debts of $200,000 and a depreciable
asset that has an adjusted basis of $75,000 and a fair market value
of $100,000. X has no other assets or liabilities. X has a net
operating loss of $80,000 that is carried over to Year 2 but has no
general business credit, minimum tax credit, or capital loss
carryovers. Under a plan of reorganization, X transfers its asset to
Corporation Y in exchange for Y stock with a value of $100,000. X
distributes the Y stock to its trade creditors in exchange for
release of their claims against X. X's shareholders receive nothing
in the transaction. The transaction qualifies as a reorganization
under section 368(a)(1)(G) that satisfies the requirements of
section 354(a)(1)(A) and (B). For Year 2, X has gross income of
$10,000 (without regard to any income from the discharge of
indebtedness) and is allowed a depreciation deduction of $10,000 in
respect of the asset. In addition, it generates no general business
credits.
(ii) Analysis. On the distribution of Y stock to X's trade
creditors, under section 108(a)(1)(A), X is entitled to exclude from
gross income the debt discharge amount of $100,000. (Under section
108(e)(8), X is treated as satisfying $100,000 of the debt owed the
trade creditors for $100,000, the fair market value of the Y stock
transferred to those creditors.) In Year 2, X has no taxable income
or loss because its gross income is exactly offset by the
depreciation deduction. As a result of the depreciation deduction,
X's basis in the asset is reduced by $10,000 to $65,000. Pursuant to
paragraph (c) of this section, the amount of X's net operating loss
to which Y succeeds pursuant to section 381 and the basis of X's
property transferred to Y must take into account the reductions
required by section 108(b). Pursuant to paragraph (a) of this
section, X's net operating loss carryover in the amount of $80,000
is reduced by $80,000 of the COD income excluded under section
108(a)(1). In addition, X's basis in the asset is reduced by
$20,000, the extent to which the COD income excluded under section
108(a)(1) did not reduce the net operating loss. Accordingly, as a
result of the reorganization, there is no net operating loss to
which Y succeeds under section 381. Pursuant to section 361, X
recognizes no gain or loss on the transfer of its property to Y.
Pursuant to section 362(b), Y's basis in the asset acquired from X
is $45,000.
Example 4. (i) Facts. The facts are the same as in Example 3,
except that X elects under section 108(b)(5) to reduce first the
basis of its depreciable asset.
(ii) Analysis. As in Example 3, on the distribution of Y stock
to X's trade creditors, under section 108(a)(1)(A), X is entitled to
exclude from gross income the debt discharge amount of $100,000. In
addition, in Year 2, X has no taxable income or loss because its
gross income is exactly offset by the depreciation deduction. As a
result of the depreciation deduction, X's basis in the asset is
reduced by $10,000 to $65,000. Pursuant to paragraph (c) of this
section, the amount of X's net operating loss to which Y succeeds
pursuant to section 381 and the basis of X's property transferred to
Y must take into account the reductions required by section 108(b).
As a result of the election under section 108(b)(5), X's basis in
the asset is reduced by $65,000 to $0. In addition, X's net
operating loss is reduced by $35,000, the extent to which the amount
excluded from income under section 108(a)(1)(A) does not reduce X's
asset basis. Accordingly, as a result of the reorganization, Y
succeeds to X's net operating loss in the amount of $45,000 under
section 381. Pursuant to section 361, X recognizes no gain or loss
on the transfer of its property to Y. Pursuant to section 362(b),
Y's basis in the asset acquired from X is $0.
(e) Effective date. This section applies to discharges of
indebtedness occurring after July 17, 2003.
0
Par. 3. Section 1.1017-1 is amended by adding paragraph (b)(4) to read
as follows:
Sec. 1.1017-1 Basis reductions following a discharge of indebtedness.
* * * * *
(b) * * *
(4) For further guidance, see Sec. 1.1017-1T(b)(4).
* * * * *
0
Par. 4. Section 1.1017-1T is added to read as follows:
Sec. 1.1017-1T Basis reductions following a discharge of indebtedness
(temporary).
(a) Through (b)(3) [Reserved]. For further guidance, see Sec.
1.1017-1(a) through (b)(3).
(4) Transactions to which section 381 applies. In the case of a
transaction described in section 381(a) that ends a taxable year in
which the distributor or transferor corporation excludes COD income
from gross income under section 108(a), the basis of property acquired
by the acquiring corporation in the transaction shall reflect the
reductions required by section 1017 and this section. For this purpose,
the basis of property of the distributor or transferor corporation
immediately prior to the transaction described in section 381(a), but
after the determination of tax for the year of the discharge, shall be
available for reduction under section 108(b)(2). See Sec. 1.108-7T.
This paragraph (b)(4) applies to discharges of indebtedness occurring
after July 17, 2003.
(c) Through (i) [Reserved]. For further guidance, see Sec. 1.1017-
1(c) through (i).
Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
Approved: July 9, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-18145 Filed 7-17-03; 8:45 am]
BILLING CODE 4830-01-P