Guidance Under Section 1032 Relating to the Treatment of a
Disposition by An Acquiring Entity of the Stock of a
Corporation in a Taxable Transaction

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8883] RIN 1545-AW53

TITLE: Guidance under Section 1032 Relating to the Treatment of a
Disposition by An Acquiring Entity of the Stock of a Corporation in
a Taxable Transaction

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the
treatment of a disposition by a corporation or partnership (the
acquiring entity) of the stock of a corporation (the issuing
corporation) in a taxable transaction. The final regulations
interpret section 1032 of the Internal Revenue Code. They affect
persons engaging in certain taxable transactions, as described in
the final regulations, occurring after May 16, 2000.

EFFECTIVE DATE: These regulations are effective May 16, 2000. FOR
FURTHER INFORMATION CONTACT: Filiz Serbes, (202) 622-7550 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On September 23, 1998, the Treasury and the IRS issued a notice of
proposed rulemaking in the Federal Register (63 FR 50816), setting
forth rules relating to the treatment of a disposition by a
corporation (the acquiring corporation) of the stock of another
corporation (the issuing corporation) in a taxable transaction. A
public hearing regarding these proposed regulations was held on
January 7, 1999. Written comments responding to the notice were
received. After consideration of all of the comments, the proposed
regulations are adopted as revised by this Treasury decision.

Explanation of Revisions and Summary of Comments

The Immediacy Requirement

The proposed regulations adopted a cash purchase model in which
certain transactions involving a contribution of issuing corporation
stock by an issuing corporation to an acquiring corporation are
recast as a contribution of cash by the issuing corporation to the
acquiring corporation, which is used by the acquiring corporation to
purchase issuing corporation stock from the issuing corporation. As
a condition for application of the cash purchase model of the
proposed regulations, the proposed regulations adopted the
requirement of §1.1502-13(f)(6)(ii)(B) that the issuing corporation
stock received by the acquiring corporation be immediately
transferred to acquire money or other property.

A number of commentators requested that the term A immediately @ be
explicitly defined. Some suggested replacing the temporal
requirement with a transactional approach, requiring only that the
stock be disposed of "pursuant to a plan of acquisition." Others
suggested that the immediacy requirement be waived in certain
circumstances, such as with respect to a nonqualified deferred
compensation arrangement involving a grantor trust (commonly
referred to as a A Rabbi Trust @ ) that is established to provide
future benefits to the employees of an acquiring corporation and
that is funded with issuing corporation stock.

After considering the purposes of section 1032 and issues of
administrative burden and technical complexity, the Treasury and the
IRS believe that the immediacy requirement should neither be waived
nor construed to permit the acquiring corporation to hold issuing
corporation stock for a period of time during which the value of the
stock could fluctuate.

The Treasury and the IRS believe that, in a case where the issuing
corporation contributes its stock to the acquiring corporation and
the acquiring corporation does not immediately dispose of that
stock, it is not appropriate to increase the basis of either the
issuing corporation stock transferred to the acquiring corporation
or the stock of the acquiring corporation held by the issuing
corporation. In the cases addressed by the proposed regulations, in
which the acquiring corporation exchanges the stock immediately for
property owned by a third party, the transaction is
indistinguishable from one in which the issuing corporation directly
exchanges its stock for the property of the third party (an exchange
to which section 1032 would apply) and contributes that property to
the acquiring corporation, a transaction whose tax result would be
the same as the cash purchase model set forth in the proposed
regulations. However, in cases where the acquiring corporation's
ownership of the issuing corporation stock is more than transitory,
there appears to be no comparable transaction which would generate
the same tax consequences as the cash purchase model.

Implementation of an approach that waives the immediacy requirement
would raise administrative and policy concerns. If the acquiring
corporation were to be permitted to hold the issuing corporation
stock for a period of time, the regulations would have to adopt one
of two alternative approaches. Under the first alternative, the
regulations would provide that the cash purchase model would be
deemed to apply at the time that the stock is contributed to the
acquiring corporation, giving the acquiring corporation a fair
market value basis in the stock.

However, such an approach would raise at least two concerns. First,
in the case that the issuing corporation stock is not publicly
traded, such an approach would impose administrative burdens
requiring a valuation of the stock at a time when there is no
related transaction to assist in such valuation. Thus, there is a
potential for the stock to be overvalued, with a result of inflating
the basis in both the contributed issuing corporation stock and the
acquiring corporation stock held by the issuing corporation.

Second, even if the valuation were accurate, providing for the cash
purchase model on the date of the contribution would facilitate
selective loss recognition. If the acquiring corporation could
receive the stock at a fair market value basis and hold on to it,
then if the value of the stock decreased, the subsidiary could sell
the stock and recognize a loss. The Treasury and the IRS believe
that it is inappropriate to issue regulations facilitating selective
loss recognition.

Under the second alternative, the regulations would suspend the
operation of the cash purchase model until such time as the
acquiring corporation actually disposes of the issuing corporation
stock. However, such an approach also would give rise to
inappropriate tax results. In addition to precluding gain
recognition attributable to the zero basis result, this alternative
would allow a subsidiary to avoid recognition of gain attributable
to real appreciation in this asset.

Assume, for example, a case where the issuing corporation
contributes issuing corporation stock worth $100 to the acquiring
corporation, the acquiring corporation retains that stock while it
appreciates to $300, and then sells the stock for $300 in cash.
Absent an immediacy requirement, under the second alternative, the
acquiring corporation would be deemed to have purchased the stock
for $300 in cash contributed by the issuing corporation immediately
before the sale of the stock to the third party. As a result, the
acquiring corporation would not recognize any gain or loss, and the
issuing corporation would increase its basis in the stock of the
acquiring corporation by $300. More than merely avoiding a zero
basis result (i.e., taxation on the $100 value in the stock when
contributed to the acquiring corporation), neither the acquiring
corporation nor the issuing corporation would ever be taxed on the
further $200 in appreciation of the issuing corporation stock which
occurred while such stock was held by the acquiring corporation.
Such a result, which effectively would provide full section 1032
protection for a subsidiary's gain in certain parent stock, would go
well beyond addressing the zero basis result, the scope of these
regulations.

Because each of those alternatives would be unsatisfactory for the
reasons discussed above, the final regulations retain the immediacy
requirement without further exception. Consistent with that
determination, and as in the case of any other transaction, the cash
purchase model of these regulations applies to arrangements
involving Rabbi Trusts only if the immediacy requirement is
satisfied. Thus, these regulations do not apply to Rabbi Trust
arrangements in which the stock of an issuing corporation is treated
for federal tax purposes as owned for a period of time by its
subsidiary.

However, the Treasury and the IRS have reconsidered certain aspects
of Rabbi Trust arrangements and have determined that the fact that
trust assets are subject to the claims of creditors of the
subsidiary corporation does not necessarily establish that the
subsidiary should be treated as a grantor of the trust at the time
the trust is funded. Guidance regarding the effects of this
reconsideration on existing Rabbi Trusts will be forthcoming. In
addition, the final regulations contain a new example describing an
arrangement in which the issuing corporation (and not the
subsidiary) is treated as the grantor and owner of the Rabbi Trust,
with the result that the immediacy requirement is satisfied upon the
transfer of issuing corporation stock by the trust to the
subsidiary's employees.

Taxpayers could have reasonably anticipated that Rabbi Trust
arrangements could not be structured without causing subsidiaries to
be treated as grantors and owners of the trust. For that reason and
because of the potential ambiguities in interpreting Rev. Rul. 80-76
(1980-1 C.B. 15), the IRS will not challenge a taxpayer's position
that no gain is recognized by an acquiring corporation upon the
disposition by a Rabbi Trust, established on or before June 15,
2000, of issuing corporation stock if that stock was contributed by
the issuing corporation to the Rabbi Trust on or before May 16,
2001.

Exchanges by the Acquiring Corporation of Stock of the Issuing
Corporation for Other Issuing Corporation Stock Commentators noted
that, unlike §1.1502-13(f)(6)(ii), the recast of the proposed
regulations applies even where the acquiring corporation exchanges
stock of the issuing corporation for other issuing corporation
stock. Allowing a subsidiary to receive parent stock it immediately
swaps for other parent stock, which it could hold long term with a
cost basis, would facilitate selective loss recognition with respect
to parent stock by a subsidiary. Accordingly, the final regulations
adopt, as a precondition for the recast, a requirement that the
issuing corporation stock not be exchanged for other issuing
corporation stock.

Exchanges by the Acquiring Corporation of Stock of the Issuing
Corporation for Acquiring Corporation Debt Commentators contended
that it is unclear whether the proposed regulations are applicable
when the acquiring corporation uses issuing corporation stock to
satisfy acquiring corporation debt. The Treasury and the IRS believe
that the regulations do apply to an exchange of issuing corporation
stock for acquiring corporation debt. Although section 1032 refers
to an exchange for money or other property and does not expressly
refer to exchanges of stock for debt, it is generally acknowledged
that section 1032 applies to an exchange of a corporation's stock
for its debt, subject to sections 61(a)(12) and 108, which provide
that a corporation may have income from a cancellation of
indebtedness on an exchange of its stock for its own debt (that is,
cancellation of indebtedness income can be realized and recognized
when debt is satisfied with stock of the debtor corporation, even
though no gain is recognized on the issuance of the stock).
Similarly, therefore, the requirement set forth in these regulations
that the acquiring corporation transfer issuing corporation stock to
acquire money or other property is satisfied where the stock is used
to satisfy acquiring corporation debt (although the acquiring
corporation may be subject to sections 61(a)(12) and 108). No
modifications to the language of the final regulations are needed to
achieve this result.

Similarly, a commentator expressed concern that the proposed
regulations do not expressly apply to an acquiring corporation's
exchange of issuing corporation stock for the acquiring
corporation's own outstanding acquiring corporation stock held by a
shareholder other than the issuing corporation. The Treasury and the
IRS believe that the regulations do apply to such an exchange.

Acquiring Corporation's Use of Issuing Corporation's Debt
Commentators also requested that the regulations be extended to
issuing corporation debt instruments used by the acquiring
corporation to acquire money or other property from unrelated third
parties. Because section 1032 only refers to corporate stock, debt
instruments are beyond the scope of these final regulations.

Reorganizations Coupled with Taxable Transactions The proposed
regulations do not apply if any party to the exchange receives a
substituted basis in the issuing corporation stock. Commentators
suggested that the final regulations provide that the above rule
does not preclude application of the final regulations if a taxable
exchange of issuing corporation stock for property accompanies a
reorganization.

The Treasury and the IRS believe that a taxable transaction to which
the regulations apply can accompany a reorganization, provided that
the exchanges are separate and that the assets acquired in the
taxable transaction and the assets acquired as part of the
reorganization can be identified. If these elements can be
established, the substituted basis prohibition should not preclude
application of the final regulations to the taxable portion of the
exchange. Accordingly, clarifying language has been added to
§1.1032-3(c)(3).

Options Without a Readily Ascertainable Fair Market Value Several
commentators asked how the proposed regulations apply to a
compensatory stock option without a readily ascertainable fair
market value. Pursuant to section 83(e)(3) and §1.83-7(a), the grant
of such options is effectively treated as an open transaction.
Section §1.83-7(a) provides that section 83(a) and (b) applies at
the time the option is exercised or is otherwise disposed of. An
example has been added to confirm that the final regulations do not
apply to such options.

When the option is exercised, section 83(a) and (b) applies to the
transfer of stock pursuant to the exercise. If all of the
requirements of §1.1032-3 are met, those regulations apply to
determine the treatment accorded the issuing corporation and the
acquiring corporation upon transfer of the issuing corporation stock
to the employee.

Reversionary Interest in Issuing Corporation Stock.11 Examples 4 and
5 of the proposed regulations set forth situations in which either
the issuing corporation (X) or the acquiring corporation (Y) retains
a reversionary interest in the issuing corporation stock. One
commentator pointed out that the preamble of the proposed
regulations does not articulate reasons for concern with
reversionary interests.

These facts were included in the examples in the proposed
regulations to indicate ownership of the stock for tax purposes.
Example 6 of the final regulations has been modified to state that X
retains the only reversionary interest in the X stock in the event
that A forfeits the right to the stock.

Actual Payment for Issuing Corporation Stock

Under the cash purchase model of the proposed regulations, the
acquiring corporation is deemed to have purchased the issuing
corporation stock from the issuing corporation for fair market value
with cash contributed to the acquiring corporation by the issuing
corporation. Commentators requested clarification of the tax
consequences in cases where the acquiring corporation or another
party makes an actual payment to the issuing corporation for issuing
corporation stock. Specifically, concern was expressed as to whether
any or all of the amounts actually paid to the issuing corporation
are treated as a distribution by the acquiring corporation to the
issuing corporation. Assume, for example, that the issuing
corporation, which owns all the stock of the acquiring corporation,
transfers an option for issuing corporation stock to an employee of
the acquiring corporation. At a time when one share of issuing
corporation stock has a fair market value of $100, that employee
exercises the option to acquire one share of issuing corporation
stock and pays a strike price of $80 to the issuing corporation. The
acquiring corporation pays some or all of the A spread @ of $20 to
the issuing corporation.

The Treasury and the IRS do not believe that an actual payment to
the issuing corporation for issuing corporation stock should be
taxed as a distribution with respect to acquiring corporation stock.
Accordingly, the final regulations have been modified to provide
that the amount of cash deemed contributed by the issuing
corporation to the acquiring corporation in the cash purchase model
is equal to the difference between the fair market value of the
issuing corporation stock and the fair market value of the money or
other property received by the issuing corporation as payment from
the employee or the acquiring corporation. An example to such effect
has been added to the final regulations.

Although in other contexts partial payments received by a
shareholder of an acquiring corporation should be characterized as
boot under section 351(b), these final regulations integrate such
payments into the cash purchase model described above. Because the
property transferred by the issuing corporation to the acquiring
corporation in this context is the issuing.13 corporation's stock
(or is deemed to be cash under the recast of these regulations),
characterization of the payment as boot in this context would have
no effect. No inference should be drawn from the recast in the final
regulations to transactions in which a shareholder receives money or
other property in exchange for property other than its own stock.

Section 1.83-6 is currently under study. A cross-reference in
§1.83-6(d) to these final regulations has been added to indicate
that the mechanics of §1.1032-3, rather than the mechanics of
§1.83-6(d), apply to a corporate shareholder's transfer of its own
stock to any person in consideration of services performed for
another entity where the conditions of the final regulations are
satisfied.

Applicability of the Final Regulations in the Partnership Context
Consistent with a suggestion by commentators that the regulations be
expanded to apply to transactions involving partnerships, the final
regulations treat an acquiring partnership's disposition of the
stock of the issuing corporation in the same manner as an acquiring
corporation's disposition of such stock. The regulations also have
been expanded to apply to transactions in which the stock of the
issuing corporation is obtained indirectly by the acquiring entity
in any combination of exchanges under sections 721 and 351.

In certain situations where the recast of the final regulations does
not apply to the disposition by a partnership of a corporate
partner's stock (for example, because the immediacy requirement is
not satisfied), realized gain or loss that is allocated to that
corporate partner may nonetheless not be recognized pursuant to
section 1032. See Rev. Rul. 99-57 (1999-51 I.R.B. 678).

Status of §1.1502-13(f)(6)(ii)

The Treasury and the IRS believe that the finalization of these
§1.1032-3 regulations renders §1.1502-13(f)(6)(ii) superfluous
because there should be no cases which would be subject to recast
under §1.1502-13(f)(6)(ii), but in which a member would A otherwise
recognize gain @ as required for §1.1502- 13(f)(6)(ii) to apply.
Accordingly, the effective date paragraph in the §1.1502-13(f)(6)
regulations has been modified to limit the applicability of
§1.1502-13(f)(6)(ii) and the last sentence of §1.1502-13(f)(6)(iv)
(A) to periods before the effective date of these regulations.

Status of Rev. Rul. 80-76

The preamble to the proposed regulations states that Rev. Rul. 80-76
(1980-1 C.B. 15) addresses the same issues as the proposed
regulations and that, when finalized, the regulations will render
Rev. Rul. 80-76 obsolete. In Rev. Rul. 80-76, a majority shareholder
of parent transfers parent stock to an employee of its subsidiary
corporation as compensation. The holding of the revenue ruling that
the subsidiary does not recognize gain or loss on the transfer of
the parent stock is now governed by these regulations. An example
has been added to the final regulations to clarify how general tax
principles (see Commissioner v. Fink, 483 U.S. 89 (1987)) and these
final regulations interact when a shareholder of the parent/issuing
corporation compensates an employee of the subsidiary/acquiring
corporation. With the finalization of these regulations, Rev. Rul.
80-76 is obsolete.

Additional Issues and Future Guidance Since issuance of the proposed
regulations, commentators have raised questions regarding the tax
treatment of restricted stock and options granted to employees
before or in connection with a transaction in which an issuing
corporation distributes the stock of the acquiring corporation under
section 355 (commonly referred to as a A spin off @ ). For example,
assume that employees of both X corporation and its subsidiary Y
corporation have outstanding options to acquire stock in X
corporation. In connection with a spin off of the Y stock by X, the
employees of both corporations have their outstanding options
converted into options to acquire stock of both X and Y, with option
terms preserving the overall values of the original options.

Commentators have requested guidance on the tax consequences to X
when, after the spin off, employees of X exercise options to acquire
Y stock and, likewise, the tax consequences to Y when, after the
spin off, employees of Y exercise options to acquire X stock.
Guidance addressing these issues will be forthcoming.

Effective Date

Commentators suggested that taxpayers who engaged in transactions
described in these final regulations prior to the effective date
should be eligible for the tax treatment prescribed by the
regulations. While the final regulations are applicable only
prospectively, the IRS will not challenge a taxpayer's position
taken in a prior period that is consistent with the requirements set
forth in the final regulations.

For a discussion of transitional relief concerning certain Rabbi
Trust arrangements, see the discussion of the immediacy requirement
above.

Effect on Other Documents

Rev. Rul. 80-76 (1980-1 C.B. 15) is obsolete.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and,
because these regulations do not impose a collection of information
on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter
6) does not apply. Pursuant to section 7805(f) of the Internal
Revenue Code, the notices of proposed rulemaking preceding these
regulations were submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on their impact on small
business.

Drafting Information

The principal author of these final regulations is Filiz A. Serbes
of the Office of the Assistant Chief Counsel (Corporate), IRS.
However, other personnel from the IRS and the Treasury Department
participated in its development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements. Adoption of
Amendments to the Regulations Accordingly, 26 CFR part 1 is amended
as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.83-6 is amended by adding two sentences to the end
of paragraph (d)(1) to read as follows:

§1.83-6 Deduction by employer.

* * * * *

(d) * * * (1) * * * For special rules that may apply to a
corporation's transfer of its own stock to any person in
consideration of services performed for another corporation or
partnership, see §1.1032-3. The preceding sentence applies to
transfers of stock and amounts paid for such stock occurring on or
after May 16, 2000.

* * * * *

Par. 3. Section 1.1032-2 is amended by:

1. Revising paragraph (e).

2. Adding paragraph (f).

The addition and revision read as follows: §1.1032-2 Disposition by
a corporation of stock of a controlling corporation in certain
triangular reorganizations.

* * * * *

(e) Stock options. The rules of this section shall apply to an
option to buy or sell P stock issued by P in the same manner as the
rules of this section apply to P stock.

(f) Effective dates. This section applies to triangular
reorganizations occurring on or after December 23, 1994, except for
paragraph (e) of this section, which applies to transfers of stock
options occurring on or after May 16, 2000.

Par. 4. Section 1.1032-3 is added to read as follows:

§1.1032-3 Disposition of stock or stock options in certain
transactions not qualifying under any other nonrecognition
provision.

(a) Scope. This section provides rules for certain transactions in
which a corporation or a partnership (the acquiring entity) acquires
money or other property (as defined in §1.1032-1) in exchange, in
whole or in part, for stock of a corporation (the issuing
corporation).

(b) Nonrecognition of gain or loss--(1) General rule. In a
transaction to which this section applies, no gain or loss is
recognized on the disposition of the issuing corporation's stock by
the acquiring entity. The transaction is treated as if, immediately
before the acquiring entity disposes of the stock of the issuing
corporation, the acquiring entity purchased the issuing
corporation's stock from the issuing corporation for fair market
value with cash contributed to the acquiring entity by the issuing
corporation (or, if necessary, through intermediate corporations or
partnerships). For rules that may apply in determining the issuing
corporation's adjustment to basis in the acquiring entity (or, if
necessary, in determining the adjustment to basis in intermediate
entities), see sections 358, 722, and the regulations thereunder.

(2) Special rule for actual payment for stock of the issuing
corporation. If the issuing corporation receives money or other
property in payment for its stock, the amount of cash deemed
contributed under paragraph (b)(1) of this section is the difference
between the fair market value of the issuing corporation stock and
the amount of money or the fair market value of other property that
the issuing corporation receives as payment.

(c) Applicability. The rules of this section apply only if, pursuant
to a plan to acquire money or other property--

(1) The acquiring entity acquires stock of the issuing corporation
directly or indirectly from the issuing corporation in a transaction
in which, but for this section, the basis of the stock of the
issuing corporation in the hands of the acquiring entity would be
determined, in whole or in part, with respect to the issuing
corporation's basis in the issuing corporation's stock under section
362(a) or 723;

(2) The acquiring entity immediately transfers the stock of the
issuing corporation to acquire money or other property (from a
person other than an entity from which the stock was directly or
indirectly acquired);

(3) The party receiving stock of the issuing corporation in the
exchange specified in paragraph (c)(2) of this section from the
acquiring entity does not receive a substituted basis in the stock
of the issuing corporation within the meaning of section 7701(a)
(42); and

(4) The issuing corporation stock is not exchanged for stock of the
issuing corporation.

(d) Stock options. The rules of this section shall apply to an
option issued by a corporation to buy or sell its own stock in the
same manner as the rules of this section apply to the stock of an
issuing corporation.

(e) Examples. The following examples illustrate the application of
this section:

Example 1. (i) X, a corporation, owns all of the stock of Y
corporation. Y reaches an agreement with C, an individual, to
acquire a truck from C in exchange for 10 shares of X stock with a
fair market value of $100. To effectuate Y's agreement with C, X
transfers to Y the X stock in a transaction in which, but for this
section, the basis of the X stock in the hands of Y would be
determined with respect to X's basis in the X stock under section
362(a). Y immediately transfers the X stock to C to acquire the
truck.

(ii) In this Example 1, no gain or loss is recognized on the
disposition of the X stock by Y. Immediately before Y's disposition
of the X stock, Y is treated as purchasing the X stock from X for
$100 of cash contributed to Y by X. Under section 358, X's basis in
its Y stock is increased by $100. Example 2. (i) Assume the same
facts as Example 1, except that, rather than X stock, X transfers an
option with a fair market value of $100 to purchase X stock.

(ii) In this Example 2, no gain or loss is recognized on the
disposition of the X stock option by Y. Immediately before Y's
disposition of the X stock option, Y is treated as purchasing the X
stock option from X for $100 of cash contributed to Y by X. Under
section 358, X's basis in its Y stock is increased by $100.

Example 3. (i) X, a corporation, owns all of the outstanding stock
of Y corporation. Y is a partner in partnership Z. Z reaches an
agreement with C, an individual, to acquire a truck from C in
exchange for 10 shares of X stock with a fair market value of $100.
To effectuate Z's agreement with C, X transfers to Y the X stock in
a transaction in which, but for this section, the basis of the X
stock in the hands of Y would be determined with respect to X's
basis in the X stock under section 362(a). Y immediately transfers
the X stock to Z in a transaction in which, but for this section,
the basis of the X stock in the hands of Z would be determined under
section 723. Z immediately transfers the X stock to C to acquire the
truck.

(ii) In this Example 3, no gain or loss is recognized on the
disposition of the X stock by Z. Immediately before Z's disposition
of the X stock, Z is treated as purchasing the X stock from X for
$100 of cash indirectly contributed to Z by X through an
intermediate corporation, Y. Under section 722, Y's basis in its Z
partnership interest is increased by $100, and, under section 358,
X's basis in its Y stock is increased by $100.

Example 4. (i) X, a corporation, owns all of the outstanding stock
of Y corporation. B, an individual, is an employee of Y. Pursuant to
an agreement between X and Y to compensate B for services provided
to Y, X transfers to B 10 shares of X stock with a fair market value
of $100. Under §1.83- 6(d), but for this section, the transfer of X
stock by X to B would be treated as a contribution of the X stock by
X to the capital of Y, and immediately thereafter, a transfer of the
X stock by Y to B. But for this section, the basis of the X stock in
the hands of Y would be determined with respect to X's basis in the
X stock under section 362(a).

(ii) In this Example 4, no gain or loss is recognized on the deemed
disposition of the X stock by Y. Immediately before Y's deemed
disposition of the X stock, Y is treated as purchasing the X stock
from X for $100 of cash contributed to Y by X. Under section 358,
X's basis in its Y stock is increased by $100.

Example 5. (i) X, a corporation, owns all of the outstanding stock
of Y corporation. B, an individual, is an employee of Y. To
compensate B for services provided to Y, B is offered the
opportunity to purchase 10 shares of X stock with a fair market
value of $100 at a reduced price of $80. B transfers $80 and Y
transfers $10 to X as partial payment for the X stock.

(ii) In this Example 5, no gain or loss is recognized on the deemed
disposition of the X stock by Y. Immediately before Y's deemed
disposition of the X stock, Y is treated as purchasing the X stock
from X for $100, $80 of which Y is deemed to have received from B,
$10 of which originated with Y, and $10 of which is deemed to have
been contributed to Y by X. Under section 358, X's basis in its Y
stock is increased by $10.

Example 6. (i) X, a corporation, owns stock of Y. To compensate Y's
employee, B, for services provided to Y, X issues 10 shares of X
stock to B, subject to a substantial risk of forfeiture. B does not
have an election under section 83(b) in effect with respect to the X
stock. X retains the only reversionary interest in the X stock in
the event that B forfeits the right to the stock. Several years
after X's transfer of the X shares, the stock vests. At the time the
stock vests, the 10 shares of X stock have a fair market value of
$100. Under §1.83- 6(d), but for this section, the transfer of the X
stock by X to B would be treated, at the time the stock vests, as a
contribution of the X stock by X to the capital of Y, and
immediately thereafter, a disposition of the X stock by Y to B. The
basis of the X stock in the hands of Y, but for this section, would
be determined with respect to X's basis in the X stock under section
362(a).

(ii) In this Example 6, no gain or loss is recognized on the deemed
disposition of X stock by Y when the stock vests. Immediately before
Y's deemed disposition of the X stock, Y is treated as purchasing
X's stock from X for $100 of cash contributed to Y by X. Under
section 358, X's basis in its Y stock is increased by $100.

Example 7. (i) Assume the same facts as in Example 6, except that Y
(rather than X) retains a reversionary interest in the X stock in
the event that B forfeits the right to the stock. Several years
after X's transfer of the X shares, the stock vests.

(ii) In this Example 7, this section does not apply to Y's deemed
disposition of the X shares because Y is not deemed to have
transferred the X stock to B immediately after receiving the stock
from X. For the tax consequences to Y on the deemed disposition of
the X stock, see §1.83-6(b).

Example 8. (i) X, a corporation, owns all of the outstanding stock
of Y corporation. In Year 1, X issues to Y's employee, B, a
nonstatutory stock option to purchase 10 shares of X stock as
compensation for services provided to Y. The option is exercisable
against X and does not have a readily ascertainable fair market
value (determined under §1.83-7(b)) at the time the option is
granted. In Year 2, B exercises the.23 option by paying X the strike
price of $80 for the X stock, which then has a fair market value of
$100.

(ii) In this Example 8, because, under section 83(e)(3), section
83(a) does not apply to the grant of the option, paragraph (d) of
this section also does not apply to the grant of the option. Section
83 and §1.1032-3 apply in Year 2 when the option is exercised; thus,
no gain or loss is recognized on the deemed disposition of X stock
by Y in Year 2. Immediately before Y's deemed disposition of the X
stock in Year 2, Y is treated as purchasing the X stock from X for
$100, $80 of which Y is deemed to have received from B and the
remaining $20 of which is deemed to have been contributed to Y by X.
Under section 358, X's basis in its Y stock is increased by $20.

Example 9. (i) A, an individual, owns a majority of the stock of X.
X owns stock of Y constituting control of Y within the meaning of
section 368(c). A transfers 10 shares of its X stock to B, a key
employee of Y. The fair market value of the 10 shares on the date of
transfer was $100.

(ii) In this Example 9, A is treated as making a nondeductible
contribution of the 10 shares of X to the capital of X, and no gain
or loss is recognized by A as a result of this transfer. See
Commissioner v. Fink, 483 U.S. 89 (1987). A must allocate his basis
in the transferred shares to his remaining shares of X stock. No
gain or loss is recognized on the deemed disposition of the X stock
by Y. Immediately before Y's disposition of the X stock, Y is
treated as purchasing the X stock from X for $100 of cash
contributed to Y by X. Under section 358, X's basis in its Y stock
is increased by $100.

Example 10. (i) In Year 1, X, a corporation, forms a trust which
will be used to satisfy deferred compensation obligations owed by Y,
X's wholly owned subsidiary, to Y's employees. X funds the trust
with X stock, which would revert to X upon termination of the trust,
subject to the employees' rights to be paid the deferred
compensation due to them. The creditors of X can reach all the trust
assets upon the insolvency of X. Similarly, Y's creditors can reach
all the trust assets upon the insolvency of Y. In Year 5, the trust
transfers X stock to the employees of Y in satisfaction of the
deferred compensation obligation.

(ii) In this Example 10, X is considered to be the grantor of the
trust, and, under section 677, X is also the owner of the trust. Any
income earned by the trust would be reflected on X's income tax
return. Y is not considered a grantor or owner of the trust corpus
at the time X transfers X stock to the trust. In Year 5, when
employees of Y receive X stock in satisfaction of the deferred
compensation obligation, no gain or loss is recognized on the deemed
disposition of the X stock by Y. Immediately before Y's deemed
disposition of the X stock, Y is treated as purchasing the X stock
from X for fair market value using cash contributed to Y by X. Under
section 358, X's basis in its Y stock increases by the amount of
cash deemed contributed.

(f) Effective date. This section applies to transfers of stock or
stock options of the issuing corporation occurring on or after May
16, 2000.

Par. 5. In §1.1502-13, paragraph (f)(6)(v) is amended by adding a
sentence after the first sentence to read as follows: §1.1502-13
Intercompany transactions.

* * * * *

(f) ***

(6) ***

(v) Effective date. *** However, paragraph (f)(6)(ii) of this
section and the last sentence of paragraph (f)(6)(iv)(A) of this
section do not apply to dispositions of P stock or options occurring
on or after May 16, 2000. ***

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved: May 5, 2000
Jonathan Talisman
Deputy Assistant Secretary of the Treasury

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