Annette M. Ahlers
The Internal Revenue Service (IRS) recently issued rulings regarding the availability of tax losses after a bankruptcy,1 the ability to take a loss under Sections 165(a) and 165(g),2 and the characterization of a loss after an ownership change.3
There are few rulings or other sources of authority for these types of
issues, and thus, a review of these rulings provides insight into the
IRS's current thinking on the issues addressed.
In PLR 201051020, the common parent (Parent A) of an affiliated group
of corporations filed a consolidated federal income tax return on
behalf of the group (the Group). The Group was formed when Parent A
acquired all the stock of Sub 1. Sub 1 held stock of other entities and
together with its other members constituted a "loss sub-group" under
Treas. Reg. Section 1.1502- 91(d)(1). The Sub 1 loss sub-group underwent
an ownership change and had a net unrealized built-in gain (NUBIG) for
Section 382 purposes when it was acquired by Parent A. Then, the entire
Group, including both Parent A and the Sub 1 loss group, underwent an
ownership change for Section 382 purposes on a date subsequent to the
acquisition date and a separate NUBIG calculation was performed on the
Group's ownership change.
Thereafter, the Group filed for bankruptcy under Chapter 11 of the
U.S. Bankruptcy Code. Under a plan of reorganization, certain assets
that were in the Sub 1 loss sub-group were to be distributed. Such
distribution was expected to generate taxable gain to the Group. The IRS
concluded that the gain on the disposition would be treated as a
"recognized built-in gain" under Section 382(h) to the extent that such
gain did not exceed either the Sub 1 loss sub-group's NUBIG on the
distributed assets or the Group's NUBIG on the distributed assets.
Thus, PLR 201051020 makes it clear that successive ownership changes
require separate NUBIG calculations on the same assets, when such assets
are sold after the second ownership change.
In PLR 201103026 a parent corporation (Parent B) obtained an
appraisal of its Sub and treated certain open accounts as indebtedness
for purposes of valuing the Sub's outstanding stock. Sub owed to Parent B
certain intercompany accounts payable under Parent B's cash management
system for amounts borrowed by Sub. Certain of the obligations were owed
under a note executed between Parent B and Sub, and certain amounts
were borrowed without a note being put in place. Under the cash
management system, Parent B pays Sub's expenses and collects Sub's
revenues. Because Sub's expenses exceeded Sub's revenues, additional
amounts were owed by Sub to Parent B.
Parent B decided to sell all of Sub's assets and wind up Sub's
business. Following the initial sale of almost all of Sub's assets,
Sub's activities were limited to disposing of its remaining assets and
winding up its affairs. Parent B intended to convert Sub to an LLC
treated as a disregarded entity under Treas. Reg. Section 301.7701-3(a)
for federal income tax purposes and to eventually terminate the LLC's
existence. As of the time of the conversion of Sub to an LLC, more than
90 percent of its gross receipts for all taxable years have been from
operating activities (not rents, royalties, interest, etc.).
The IRS found that Parent B was entitled to a worthless securities
deduction under Sections 165(a) and 165(g)(3) for its Sub common stock
upon the conversion of Sub to an LLC, which was treated as a deemed
liquidation of Sub, regardless of whether the intercompany amounts owed
to Parent B were debt or equity for federal income tax purposes.
In this PLR, the IRS instructs the taxpayer to apply the provisions
of Treas. Reg. Section 1.1502-36 for purposes of determining Parent B's
basis in Sub stock, Parent B's basis in the intercompany debts, and the
effect on Sub's attributes that will result on the loss on Sub's stock.
Thus, Parent B was permitted to take into account its economic loss on
its Sub's activities, regardless of the form of the investment.
In PLR 201105031 a taxpayer was seeking to acquire a target bank (the
Bank) holding a portfolio of loans that were worth less than their face
amount. The Bank had a class of stock that was issued to the government
under the Troubled Asset Relief Program (TARP). The acquisition would
be accomplished through a merger whereby the stock of the Bank,
including the TARP preferred stock, would convert into common and
preferred stock of the taxpayer (SubBank). The merger would cause an
ownership change under Section 382(g)(1). On the change date Sub- Bank
will have both net operating losses and assets that result in a
net-unrealized built-in loss (NUBIL) under Section 382(h) (3)(A)(i). The
NUBIL is primarily attributable to the excess of the adjusted basis of
the SubBank's debt portfolio over its fairmarket value on the change
date. SubBank intends to charge-off certain debts held by the Bank prior
to the merger and take a bad-debt deduction under Section 166(a) and
Reg. Sections 1.166-2(d) and 1.166-3(a)(2). These bad-debt deductions
will be taken into account during and after the first year of the
five-year recognition period of Section 382(h)(7)(3). SubBank intends to
utilize the Section 1374 approach described in Notice 2003-654 to identify which of its deductions will be recognized built-in losses under Section 382(h)(2)(B).
The IRS ruled that any bad-debt deduction under Section 166 arising
from a debt owed to SubBank at the beginning of the five-year
recognition period will not be a recognized built-in loss if the
deduction is properly taken into account after the first 12 months of
the recognition period. The IRS cites Treas. Reg. Section 1.1374-4(b)(2)
for the position.
Few recent rulings or other authorities address losses within a group
and the application of Section 382 in a bankruptcy setting, or
post-change recognition treatment. Thus, these three rulings provide
important insight into the IRS's current positions on such transactions.
While a PLR issued to another taxpayer is not precedential authority
under Section 6110(k), a PLR is an item of substantial authority that
can be helpful in determining potential supportable positions on these
1 See PLR 201051020.
2 See PLR 201103026.
3 See PLR 201105031.
4 2003-40 I.R.B. 747.
material in this publication was created as of the date set forth above
and is based on laws, court decisions, administrative rulings and
congressional materials that existed at that time, and should not be
construed as legal advice or legal opinions on specific facts. The
information in this publication is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client
article is republished with permission of Pepper Hamilton LLP. Further
duplication without the permission of Pepper Hamilton LLP is prohibited.
All rights reserved.
Discover the features and benefits of LexisNexis® Tax Center
For quality Tax & Accounting research resources, visit the LexisNexis® Store
For more information about LexisNexis products and
solutions connect with us through our corporate