Purchase Price Allocations in
Deemed & Actual Asset Acquisitions
DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8940] RIN 1545-
AY73
TITLE: Purchase Price Allocations in Deemed and Actual Asset
Acquisitions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations and removal of temporary regulations.
SUMMARY: This document contains final regulations relating to deemed
and actual asset acquisitions under sections 338 and 1060. The final
regulations affect sellers and buyers of corporate stock that are
eligible to elect to treat the transaction as a deemed asset
acquisition. The final regulations also affect sellers and buyers of
assets that constitute a trade or business.
DATES: Effective Date These regulations are effective March 16,
2001. Applicability Dates For dates of applicability of these
regulations, see §§1.338(i)-1 and 1.1060-1(a)(2).
FOR FURTHER INFORMATION CONTACT: Richard Starke of the Office of
Associate Chief Counsel (Corporate), (202) 622-7790 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final
regulations have been reviewed and approved by the Office of
Management and Budget in accordance with the Paperwork Reduction Act
of 1995 (44 U.S.C. 3507(d)) under the control number 1545-1658.
An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it
displays a valid control number assigned by the Office of Management
and Budget.
The collections of information in these regulations are in
§§1.338-2(d), 1.338-2(e)(4), 1.338-5(d)(3), 1.338-10(a)
(4), 1.338(h)(10)-1(d)(2), and 1.1060- 1(e)(ii)(A) and (B). The
collections of information are necessary to make an election to
treat a sale of stock as a sale of assets, to calculate and collect
the appropriate amount of tax in a deemed or actual asset
acquisition, and to determine the bases of assets acquired in a
deemed or actual asset acquisition.
These collections of information are required to obtain a
benefit. The likely respondents and/or recordkeepers are small
businesses or organizations, businesses, or other for-profit
institutions, and farms.
The regulations provide that a section 338 election is made by
filing Form 8023. The burden for this requirement is reflected in
the burden of Form 8023. The regulations also provide that both a
seller and a purchaser must each file an asset acquisition statement
on Form 8594. The burden for this requirement is reflected in the
burden of Form 8594. With respect to Form 8023, the IRS estimated
that 201 forms would be filed each year and that each taxpayer would
require 12.98 hours to comply. With respect to Form 8594, the IRS
estimated that 20,000 forms would be filed each year and that each
taxpayer would require 12.25 hours to comply. These estimates have
been made available for public comment and no public comments have
been received.
The burden for the collection of information in §1.338-2(e)(4)
is as follows:
Estimated total annual reporting/recordkeeping burden: 25 hours
Estimated average annual burden per respondent/recordkeeper: 0.56
hours
Estimated number of respondents/recordkeepers: 45
Estimated annual frequency of responses: On occasion
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Reven e Service , Attn: IRS Reports Clearance Officer,
W:CAR:MP:FP:S:O, Washington, DC 20224, and to the Office of
Management and B dget , Attn: Desk Officer for the DEPARTMENT OF THE
TREASURY, Office of Information and Regulatory Affairs, Washington,
DC 20503.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.
Background
On August 10, 1999, the IRS and the Department of Treasury
(Treasury) published a notice of proposed rulemaking in the Federal
Register (REG- 107069-97, 64 FR 43462 (1999-36 I.R.B. 346))
containing proposed regulations under sections 338 and 1060 of the
Internal Revenue Code of 1986. On January 7, 2000, the IRS and
Treasury published temporary regulations in the Federal Register
(REG-107069-97, 65 FR 1236 (2000-4 I.R.B. 332)) that are virtually
the same as the proposed regulations published on August 10, 1999.
The preamble to the temporary regulations notes that the proposed
regulations generally were favorably received and that the IRS and
Treasury believe that the proposed regulations provided clearer
guidance and better rules than the prior regulations under sections
338 and 1060. However, the preamble also notes that the comments
received warranted further consideration.
Explanation of Provisions
In general, the final regulations adopted herein are very similar
to the proposed and temporary regulations in their organization and
substance. However, changes have been made in several areas, largely
in response to the comments received. The principal changes are
discussed below, in the order in which they appear in the
regulations.
Insurance Transactions
Although section 338 treats a target as having sold all its assets
in the deemed asset sale, proposed §1.338-1(a)(2) provides that
other rules of law may characterize the transaction as something
other than or in addition to a sale and purchase of assets. Proposed
§1.338-1(a)(2) states: "[f]or example, if target is an
insurance company for which a section 338 election is made, the
deemed asset sale would be characterized and taxed as an assumption-
reinsurance transaction under applicable Federal income tax law."
Several comments urged removal of the quoted sentence in the final
regulations and recommended that the treatment of transactions
involving insurance companies under section 338 be reserved pending
more complete analysis and guidance. The IRS and Treasury believe
that generally it is appropriate to view the deemed asset sale by an
insurance company as involving an assumption-reinsurance transaction
and, therefore, have retained the sentence in the final regulations.
The IRS and Treasury, however, intend to provide additional guidance
in a separate project.
Residual Method Anti-abuse Rule
The proposed regulations include a new anti-abuse rule intended to
prevent taxpayers from changing the results of applying the residual
method by engaging in transactions that have a transitory economic
effect with respect to the ownership or use of assets. The anti-
abuse rule is intended to apply only to an asset transfer exhibiting
objective characteristics suggesting the transfer was engaged in to
manipulate the operation of the residual method. Notwithstanding the
limited scope of the anti-abuse rule, several commentators suggested
further limiting or eliminating the rule. After studying the
comments, the IRS and Treasury continue to believe that the anti-
abuse rule serves a useful purpose in protecting the operation of
the residual method. Several changes have been made, however, to
clarify the intended scope of the rule. Thus, the phrase "to more
than an insignificant extent" is changed in the final regulation to
"primarily." This change is meant to clarify that some continuing
use in its original location of an asset transferred to or from the
target is permitted.
A comment requested that the final regulations elaborate further
on the statement that the Commissioner has the authority to make
appropriate correlative adjustments and that the final regulations
include an example. The final regulations do not do so, because the
nature of any correlative adjustments would depend on the particular
factual circumstances in which the rule is applied. Thus, any
additional guidance would provide only limited assistance. However,
the final regulations state that correlative adjustments should
avoid duplication or omission of any item of income, gain, loss,
deduction, or basis. See §1.338-1(c).
Closing Date Issues
Concerns have been raised about the possibility that buyers can
effectuate transactions outside the ordinary course of business
after acquiring target stock that, to the detriment of an
unsuspecting seller, must be reported by the seller on its return,
which normally covers the entire day on which the acquisition
occurs. Some of these concerns derive from a reading of
§1.1502- 76(b) to preclude operation of the "next day rule"
whenever a section 338 election is made for a target. The "next day
rule" of §1.1502-76(b) provides that if, on the day of a group
member's change in status as a member, a transaction occurs that is
properly allocable to the portion of the member's day after the
event resulting in the change, the member and all related persons
must treat the transaction as occurring at the beginning of the
following day.
Commentators have suggested that a purchaser acquiring stock of a
subsidiary member of a consolidated group could, after acquiring the
target stock, cause the target to sell all of its assets to another
person later on the closing date and then make a unilateral section
338(g) election. It is suggested that the effect of the election is
to preclude the operation of the next day rule, causing the results
of the actual asset sale to fall onto the selling consolidated
group's tax return. The IRS and Treasury do not believe that
§1.1502-76(b), as written, automatically precludes the
operation of the next day rule in a section 338 context, but
nevertheless have provided a new rule in these final regulations
that requires the application of the next day rule in a section 338
context where the target engages in a transaction outside the
ordinary course of business on the acquisition date after the event
resulting in the qualified stock purchase (QSP). See
§1.338-1(d).
Purchase Definition
Proposed §1.338-3(b)(2) provides rules concerning the
definition of a "purchase" that require more than a nominal amount
to be paid for the stock of the target. Several comments requested
reconsideration of the proposed rule. Accordingly, in the temporary
regulations, at §1.338-3T(b)(2), a definition is given for the
term purchase of target affiliate, while the definition of the term
purchase of target is reserved. The final regulations include a
single definition of purchase applicable to both targets and target
affiliates, which definition generally conforms to the definition of
purchase of target affiliate in the temporary regulations. Under
this definition, stock in a target (or target affiliate) may be
considered purchased if, under general principles of tax law, the
purchasing corporation is considered to own stock of the target (or
target affiliate) meeting the requirements of section 1504(a)(2),
notwithstanding that no amount may be paid for (or allocated to) the
stock. Transactions After QSPs
Since 1995, the regulations under section 338 have provided
special rules that apply, by virtue of section 338, to certain
transfers of target assets following a QSP of the target's stock if
a section 338 election is not made for the target. These provisions
modify the normal operation of the continuity of interest
requirement under section 368 and the interpretation of the term
shareholder for purposes of section 368(a)(1)(D), as applied to
certain taxpayers. These rules were adopted to effectuate
Congressional intent, in replacing former section 334(b)(2) with
section 338, that the deemed sale results provided by section 338
not be available through transactions within the purchasing group
after the acquisition. In the final regulations, these rules are
located at §1.338-3(d).
The 1995 amendments did not provide any special rule to modify the
application of the statutory requirements for reorganizations under
section 368(a)(1)(C). However, the considerations that justify the
modified application of the continuity of interest rule and the
shareholder definition for "D" reorganizations also justify an
analogous modification of the "solely for voting stock" requirement
for post-acquisition "C" reorganizations. Accordingly, the final
regulations provide that consideration other than voting stock
issued in connection with a QSP is ignored in determining whether a
subsequent transfer of assets by the target corporation to a member
of its new affiliated group satisfies the solely for voting stock
requirement of a "C" reorganization. See §1.338-3(d)(4).
Treatment of Liabilities
The proposed regulations eliminate the prior distinction between
"modified aggregate deemed sale price" (or MADSP) and "aggregate
deemed sale price" (or ADSP), a distinction that appeared to have
been based on the premise that the new target generally will not
bear the tax liability for the deemed sale where a section 338(h)
(10) election is made, but that it generally will bear the liability
where a section 338 (but not section 338(h)(10)) election is made.
However, these generalizations were not universally correct in
either situation. Proposed §§1.338-4 and 1.338-5 clarify
the treatment of taxes as liabilities in computing ADSP and
"adjusted grossed-up basis" (or AGUB). Commentators asked for
further clarification of the standards for taking certain taxes into
account. Rather than providing more specific guidance, which would
be inconsistent with the overall philosophy of deferring to general
tax principles governing actual transactions, the final regulations
further simplify the discussion of liabilities. Except for the fact
that new target remains liable for old target's tax liabilities (see
§1.338-1(b)(3)(i)) and that a buyer's assumption of a seller's
income tax liability with respect to the sale causes the
consideration to "gross up" or "pyramid," a tax liability is like
any other type of liability and the status of any particular type of
tax liability as a liability includible in ADSP or AGUB should be
determined under general principles as applied to the facts relating
to the incidence of the tax liability.
Valuation Rules
Proposed §1.338-6(a)(2)(iii) retains a statement from prior
versions of the regulations that "[i]n certain cases the IRS may
make an independent showing of the value of goodwill and going
concern value as a means of calling into question the validity of
the taxpayer's valuation of other assets." This authority was
intended to provide a means of ensuring that taxpayers do not
overvalue assets in higher classes that are allocated consideration
before the residual class. As a factual matter, the IRS and Treasury
understand that a low (or no) allocation to goodwill and going
concern value may result from causes other than a taxpayer's
overvaluation of assets in higher classes. Moreover, the IRS and
Treasury accept the soundness of the fundamental premise of the
residual method --- that goodwill and going concern value are the
most difficult assets to value independently and that their value
should be computed as the residue after all other assets are valued.
The final regulations delete the sentence about valuing goodwill and
going concern value. Under the final regulations, the IRS retains
the ability to challenge a taxpayer's valuation of assets in Classes
I through VI, but will do so on grounds consistent with the residual
method of allocation.
Top-Down Allocation
Changes to the rules for allocating purchase price to the stock
and assets of lower tier subsidiaries were not proposed, although,
as noted in the preamble to the proposed regulations, considerable
study was given to alternative approaches. Comments were requested,
but none was received, and the IRS and Treasury to date have been
unable to develop a fully successful alternative. Accordingly, the
final regulations continue to apply the "top-down" allocation
system, under which the stock of a lower tier subsidiary is
allocated purchase price in the general asset category (now Class V)
and the deemed purchase price of its assets is in turn computed from
that stock price and then allocated within the subsidiary.
In the final regulations, the scope of Class II assets described
in §1.338- 6(b)(2)(ii) is modified to provide that Class II
assets do not include stock of target affiliates, other than
actively traded stock described in section 1504(a)(4) (certain
preferred stock). Instead, stock of target affiliates is included in
Class V. This would exclude target affiliate stock from Class II
where the target holds an 80 percent or greater interest in the
target affiliate but a minority interest in target affiliate stock
of the same class is actively traded. It is not clear that the
trading price for shares of a class of stock less than 20 percent of
which is in the hands of the public, and which consequently may
experience thinner trading volumes, necessarily is indicative of the
fair market value of the 80 percent or greater majority interest.
Class III Assets
Proposed §1.338-6(b)(2) provides that Class III assets
consist of "accounts receivable, mortgages, and credit card
receivables from customers which arise in the ordinary course of
business." Comments suggested that these categories were too
limited. Under the rationales expressed in the preamble to the
proposed regulations, the IRS and Treasury believe that other types
of debt instruments, and even other types of assets, should be
included in Class III. As revised in the final regulations, Class
III assets generally consist of assets that the taxpayer marks to
market at least annually and debt instruments (including
receivables). However, debt instruments issued by related parties,
and certain contingent payment and convertible debt instruments, are
not included in Class III.
First Year Price Adjustments
Proposed §1.338-7 provides rules for allocating the ADSP or
AGUB when increases or decreases are required after the close of new
target's first taxable year. For increases or decreases required
before the end of new target's first taxable year, proposed
§1.338-4(b)(2)(ii) provides that "[i]ncreases or decreases with
respect to the elements of ADSP that are taken into account before
the close of new target's first taxable year are taken into account
for purposes of determining ADSP and the deemed sale tax
consequences as if they had been taken into account at the beginning
of the day after the acquisition date." Proposed §1.338-5(b)(2)
(ii) contains a similar rule for redeterminations of AGUB. These
rules originated in predecessor versions of the regulations under
section 338.
Although no commentator requested removal of these rules, one
comment highlighted the difficulties posed for the seller in section
338(h)(10) transactions in applying a rule based on new target's
year-end, and requested relief. After reviewing this comment, the
final regulations remove the rules providing special treatment for
changes in ADSP or AGUB occurring before the close of new target's
first taxable year. Instead, the general rule in §1.338-7
governs the allocation of all changes in ADSP or AGUB after the
acquisition date. This change is consistent with the IRS's and
Treasury's expressed intent in drafting the proposed regulations to
eliminate, to the extent possible, any special accounting rules in
the section 338 regulations, as it should result in treatment more
consistent with that of an actual asset sale. Like-kind Exchanges
A commentator suggested that the final regulations should apply
section 1031 to old target in its deemed asset sale if the purchaser
pays for target stock with property of like kind to old target's
assets or with cash put in escrow for a successor to old target to
designate for purchase of assets of like kind. This rule would be an
exception to the requirement in §1.338-1(a)(2) that the
transaction between old target and new target must be a taxable
transaction, and inconsistent with the requirement of section 338(a)
(1) that target "shall be treated as having sold all of its assets
at the close of the acquisition date at fair market value . . . ."
After considering the policy concerns and the administrative
difficulties in creating and administering an exception for section
1031 exchanges, the IRS and Treasury have not adopted this
suggestion. S Corporations
A purchaser may agree to compensate the sellers of an S
corporation target for adverse tax consequences resulting from a
section 338(h)(10) election. When more than one shareholder in an S
corporation sells stock in the same transaction, the different
shareholders may negotiate different prices for their stock based on
varying Federal and state tax liabilities they will bear as a result
of the transaction. Some commentators have noted that, in other
cases, different prices may be paid for control premiums or other
reasons. Under section 1361(b)(1)(D), an S corporation is permitted
to have only one class of stock. A potential second class of stock
issue arises because the fiction of a section 338(h)(10) election is
that the target sells its assets to a new target and then
liquidates. Applying that fiction, if the shareholders are treated
as receiving differing amounts per share in the deemed liquidation,
a second class of stock could result.
Some commentators have recommended that the final regulations
clarify that the payment of varying amounts per share to S
corporation shareholders will not cause the S corporation to violate
the single class of stock requirement. The final regulations respond
to these comments by including a statement in §1.1361-1(l)(2)
(v) that the payment of varying amounts to S corporation
shareholders in a transaction for which a section 338(h)(10)
election is made will not cause the S corporation to violate the
single class of stock requirement of section 1361(b)(1)(D) and
§1.1361-1(l), provided that the varying amounts are negotiated
in arm's length negotiations with the purchaser.
One commentator requested clarification regarding the calculation
and allocation of the purchaser's AGUB for a target that was an S
corporation that owned a qualified subchapter S subsidiary (QSub),
where the QSub status does not continue after the acquisition date
and the QSub is treated as becoming a separate subsidiary of new
target. Although the regulations require allocation of the AGUB
among the target's assets held at the beginning of the day after the
acquisition date, they also require results consistent with those
that would occur if the parties had actually engaged in the
transactions deemed to occur because of section 338(h)(10), and
taking into account other transactions that actually occurred or are
deemed to occur. See §1.338(h)(10)-1(d)(9). An actual sale of
the assets of the S corporation target, including the stock of the
QSub, to a corporation would be treated as a sale by the S
corporation of all of its assets, including those of the QSub. If
the QSub status does not continue after the acquisition, the buyer
would be treated as forming a new subsidiary containing the assets
held by the former QSub. See §1.1361-5(b)(3) Example 9.
Accordingly, the AGUB for the former S corporation target would be
allocated among the assets of the former QSub as though they were
assets of the target, and then the target would be treated as having
formed a new subsidiary containing the assets of the former QSub.
Clarification was also requested regarding the possibility of
making a section 338(h)(10) election for the sale by an S
corporation of stock of a QSub. As noted above, Example 9 of
§1.1361-5(b)(3) indicates that the sale by an S corporation of
all of the stock of a QSub is treated as an asset sale by the S
corporation to the purchaser of the QSub stock. No further guidance
is provided in these regulations. The sale of an 80 percent or
greater (but less than 100 percent) interest in the stock of a QSub
is not expected to be a common transaction because it generally will
result in a taxable transaction with respect to all the assets of
the QSub.
Forms 8023 and 8594
The current temporary regulations provide that a section 338(h)
(10) election for an S corporation target must be made jointly by
the purchaser and the S corporation shareholders. These regulations
specifically require nonselling S corporation shareholders to
consent to the election. See §1.338(h)(10)-1T(c)(2). However,
the instructions for the election form (Form 8023) do not clearly
require the nonselling shareholders to sign the election form.
Moreover, the prior regulations were less clear in requiring
nonselling S corporation shareholders to consent to the election.
Commentators have requested that the IRS recognize the validity of
section 338(h)(10) elections for S corporation targets even if not
signed by nonselling shareholders. The IRS will revise Form 8023 to
make clear that nonselling S corporation shareholders must also
sign. The IRS will recognize the validity of otherwise valid
elections made on the current version of the form even if not signed
by the nonselling shareholders, provided that the S corporation and
all of its shareholders (including nonselling shareholders) report
the tax consequences consistently with the results under section
338(h)(10). See §1.338(i)-1(b). The preamble to the proposed
regulations indicates that the IRS and Treasury were considering
requiring that the information about the allocation of ADSP and AGUB
currently submitted on the election form (Form 8023) instead be
submitted by the purchaser and seller(s) separately on their income
tax returns. Such a change will be effectuated when Form 8023 is
revised. The information about ADSP and AGUB will be reported by
each party separately on Form 8594, which also will be revised. With
respect to a transaction subject to a section 338 election, Form
8594 will be filed with the income tax returns of the old and new
target for the tax periods including the deemed sale and purchase.
Where an election under section 338(g) is made for a controlled
foreign corporation (CFC), the purchaser and seller (or their U.S.
shareholder(s)) will be required to submit separately, on Form 8594,
information about ADSP and AGUB. The Form 8594 will be required to
be attached to the last Form 5471 filed by the seller for old
target, and to the first Form 5471 filed by the purchaser for new
target.
Special Analyses
It has been determined that these final regulations are not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has been
determined that a final regulatory flexibility analysis is required
for the collection of information in this Treasury decision under 5
U.S.C. 604. This analysis is set forth below under the heading
"Final Regulatory Flexibility Act Analysis." Pursuant to section
7805(f) of the Internal Revenue Code, these final regulations will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
Final Reg latory Flexibility Act Analysis
This analysis is required under the Regulatory Flexibility Act (5
U.S.C. chapter 6). This regulatory action is intended to simplify
and clarify the current rules relating to both deemed and actual
asset acquisitions. The current rules were developed over a long
period of time and have been repeatedly amended. The IRS and
Treasury believe these final regulations will significantly improve
the clarity of the rules relating to both deemed and actual asset
acquisitions.
The major objective of these final regulations is to modify the
rules for allocating purchase price in both deemed and actual asset
acquisitions. In addition, these final regulations replace the
general rules for electing to treat a stock sale as an asset sale.
These collections of information may affect small businesses if
the stock of a corporation which is a small entity is acquired in a
qualified stock purchase or if a trade or business which is also a
small business is transferred in a taxable transaction. Form 8023
(on which an election to treat a stock sale as an asset sale is
filed) has been submitted to and approved by the Office of
Management and Budget. With respect to Form 8023, the IRS estimated
that 201 forms would be filed each year and that each taxpayer would
require 12.98 hours to comply. Form 8594 (on which a sale or
acquisition of assets constituting a trade or business is reported)
has also been submitted to and approved by the Office of Management
and Budget. With respect to Form 8594, the IRS estimated that 20,000
forms would be filed each year and that each taxpayer would require
12.25 hours to comply. These estimates have been made available for
public comment and no public comments have been received. The
regulations do not impose new requirements on small businesses and,
in fact, should lessen any difficulties associated with the existing
reporting requirements by clarifying the rules associated with
deemed and actual asset acquisitions.
The collections of information require taxpayers to file an
election in order to treat a stock sale as an asset sale. In
addition, taxpayers must file a statement regarding the amount of
consideration allocated to each class of assets under the residual
method. The professional skills that would be necessary to make the
election or allocate the consideration would be the same as those
required to prepare a return for the small business. Drafting
Information
The principal author of these regulations is Richard Starke,
Office of the Associate Chief Counsel (Corporate). However, other
personnel from the IRS and Treasury Department participated
extensively in their development. List of S bjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements. Adoption of Amendments to
the Regulations Accordingly, 26 CFR parts 1 and 602 are amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
removing the entries for Sections 1.338-6T, 1.338-7T, 1.338-10T and
1.1060-1T and by adding entries in numerical order to read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.338-6 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-7 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-10 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.1060-1 also issued under 26 U.S.C. 1060.* * *
Par. 2. In the list below, for each section indicated in the left
column, remove the language in the middle column and add the
language in the right column:
Section Remove Add 1.56(g)-1(k)(1), of §1.338-6T(b), if of
§1.338-6(b), if second sentence otherwise otherwise
1.56(g)-1(k)(1), of §1.338-6T(c)(1) and of §1.338-6(c)(1)
and (2) last sentence (2) also also 1.197-2(e)(1), See
§1.1060-1T(b)(2) See §1.1060-1(b)(2) second sentence
1.197-2(k), Example 6, See §1.338-6T(b) See §1.338-6(b)
paragraph (i), last sentence 1.197-2(k), Example 6, Under
§§1.1060- Under §§1.1060-1(c)(2) paragraph (ii),
second 1T(c)(2) and 1.338- and 1.338-6(c)(1) sentence 6T(c)(1),
1.197-2(k), Example 6, See §§1.1060-1T(c)(2) See
§§1.1060-1(c)(2) paragraph (ii), last and 1.338-6T(b) and
1.338-6(b) sentence 1.197-2(k), Example 23, (as these terms are (as
these terms are paragraph (iv), first defined as in defined in
defined as in defined in sentence §1.338-1(c)(13))
§1.338&ndas-2(c)(17))
1.338-8(h)(1), last nomenclature of §1.338- nomenclature of
§1.338- sentence 1(b) and (c) and 2(b) and (c) and 1.338-9(a),
penultimate provided in §1.338- provided in §1.338-
sentence 1(c)(14), 2(c)(18), 1.338-9(b)(1), first the deemed sale
gain, the deemed sale tax sentence as defined in §1.338-
consequences, as 3(b)(4), defined in §1.338- 2(c)(7),
1.338-9(b) (1), last the deemed sale gain. the deemed sale tax
sentence consequences.
1.338-9(b)(3)(i)(B) under §1.338(b)-1(e)(2). under
§1.338-5(d).
1.338-9(b)(3)(ii) reflect deemed sale reflect deemed sale tax gain
consequences)
1.338-9(b)(4) under §1.338(b)-1(e)(2), under §1.338-5(d),
1.338-9(f)(2), Example and §1.338(b)-1(e)(2). and
§1.338-5(d).
1, paragraph (a), last sentence 1.368-1(a), third (k) and
1.338-3T(c)(3). (k) and 1.338-3(d). sentence 1.368-1(e)(6), Example
see §1.338-3T(c)(3) see §1.338-3(d) (which 4, paragraph
(ii), last (which sentence 1.597-2(d)(5)(iii)(B) (see
§1.338-7T) (see §1.338-7)
1.597-5(c)(3)(i) under §1.338-6T(b), under §1.338-6(b),
(c)(1) and (2). (c)(1) and (2).
1.597-5(d)(2)(i) under §1.338-6T(b), under §1.338-6(b),
(c)(1) and (2). (c)(1) and (2).
1.921-1T(b)(1), A-1, and §1.338-2T(d). and §1.338-2(d).
immediately preceding the penultimate sentence 1.1031(d)-1T, see
§1.1060-1T(b), (c), see §1.1060-1(b), (c), last sentence
and (d) Example 1. and (d) Example 1.
1.1031(j)-1(b)(2)(iii), in §1.338-6T(b), to in
§1.338-6(b), to which penultimate sentence which reference is
made reference is made by §1.1060-1T(c)(2).
§1.1060-1(c)(2).1.1361-4(d), Example 3, Under section 338(a)
Under section 338(a) third sentence and §1.338(h)(10)- and
§1.338(h)(10)-1T(d)(3), 1(d)(3), 1.1502-75(k) See
§1.338(h) (10)- See §1.338(h)(10)-1T(d)(7) for 1(d)(7) for
1.1502- See §1.338-10T(a)(5) See §1.338-10(a)(5) 76(b)(1)
(ii)(A)(1), (deemed (deemed last sentence Par. 3. Sections 1.338-0
through 1.338-7 are added to read as follows: §1.338-0 Outline
of topics. This section lists the captions contained in the
regulations under section 338 as follows:
§1.338-1 General principles; status of old target and new
target.
(a) In general.
(1) Deemed transaction.
(2) Application of other rules of law.
(3) Overview.
(b) Treatment of target under other provisions of the Internal
Revenue Code.
(1) General rule for subtitle A.
(2) Exceptions for subtitle A.
(3) General rule for other provisions of the Internal Revenue Code.
(c) Anti-abuse rule.
(1) In general.
(2) Examples.
(d) Next day rule for post-closing transactions. §1.338-2
Nomenclature and definitions; mechanics of the section 338 election.
(a) Scope.
(b) Nomenclature.
(c) Definitions.
(1) Acquisition date.
(2) Acquisition date assets.
(3) Affiliated group.
(4) Common parent.
(5) Consistency period.
(6) Deemed asset sale.
(7) Deemed sale tax consequences.
(8) Deemed sale return.
(9) Domestic corporation.
(10) Old target's final return.
(11) Purchasing corporation.
(12) Qualified stock purchase.
(13) Related persons.
(14) Section 338 election.
(15) Section 338(h)(10) election.
(16) Selling group.
(17) Target; old target; new target.
(18) Target affiliate.
(19) 12-month acquisition period.
(d) Time and manner of making election.
(e) Special rules for foreign corporations or DISCs.
(1) Elections by certain foreign purchasing corporations.
(i) General rule.
(ii) Qualifying foreign purchasing corporation.
(iii) Qualifying foreign target.
(iv) Triggering event.
(v) Subject to United States tax.
(2) Acquisition period.
(3) Statement of section 338 may be filed by United States
shareholders in certain cases.
(4) Notice requirement for U.S. persons holding stock in foreign
target.
(i) General rule.
(ii) Limitation.
(iii) Form of notice.
(iv) Timing of notice.
(v) Consequence of failure to comply.
(vi) Good faith effort to comply. §1.338-3 Qualification for
the section 338 election.
(a) Scope.
(b) Rules relating to qualified stock purchases.
(1) Purchasing corporation requirement.
(2) Purchase.
(3) Acquisitions of stock from related corporations.
(i) In general.
(ii) Time for testing relationship.
(iii) Cases where section 338(h)(3)(C) applies--acquisitions treated
as purchases.
(iv) Examples.
(4) Acquisition date for tiered targets.
(i) Stock sold in deemed asset sale.
(ii) Examples.
(5) Effect of redemptions.
(i) General rule.
(ii) Redemptions from persons unrelated to the purchasing
corporation.
(iii) Redemptions from the purchasing corporation or related persons
during 12- month acquisition period.
(A) General rule.
(B) Exception for certain redemptions from related corporations.
(iv) Examples.
(c) Effect of post-acquisition events on eligibility for section 338
election.
(1) Post-acquisition elimination of target.
(2) Post-acquisition elimination of the purchasing corporation.
(d) Consequences of post-acquisition elimination of target where
section 338 election not made.
(1) Scope.
(2) Continuity of interest.
(3) Control requirement.
(4) Solely for voting stock requirement.
(5) Example. §1.338-4 Aggregate deemed sale price; various
aspects of taxation of the deemed asset sale.
(a) Scope.
(b) Determination of ADSP.
(1) General rule.
(2) Time and amount of ADSP.
(i) Original determination.
(ii) Redetermination of ADSP.
(iii) Example.
(c) Grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock.
(1) Determination of amount.
(2) Example.
(d) Liabilities of old target.
(1) In general.
(2) Time and amount of liabilities.
(e) Deemed sale tax consequences.
(f) Other rules apply in determining ADSP.
(g) Examples.
(h) Deemed sale of target affiliate stock.
(1) Scope.
(2) In general.
(3) Deemed sale of foreign target affiliate by a domestic target.
(4) Deemed sale producing effectively connected income.
(5) Deemed sale of insurance company target affiliate electing under
section 953(d).
(6) Deemed sale of DISC target affiliate.
(7) Anti-stuffing rule.
(8) Examples. §1.338-5 Adjusted grossed-up basis.
(a) Scope.
(b) Determination of AGUB.
(1) General rule.
(2) Time and amount of AGUB.
(i) Original determination.
(ii) Redetermination of AGUB.
(iii) Examples.
(c) Grossed-up basis of recently purchased stock.
(d) Basis of nonrecently purchased stock; gain recognition election.
(1) No gain recognition election.
(2) Procedure for making gain recognition election.
(3) Effect of gain recognition election.
(i) In general.
(ii) Basis amount.
(iii) Losses not recognized.
(iv) Stock subject to election.
(e) Liabilities of new target.
(1) In general.
(2) Time and amount of liabilities.
(3) Interaction with deemed sale tax consequences.
(f) Adjustments by the Internal Revenue Service.
(g) Examples. §1.338-6 Allocation of ADSP and AGUB among target
assets.
(a) Scope.
(1) In general.
(2) Fair market value.
(i) In general.
(ii) Transaction costs.
(iii) Internal Revenue Service authority.
(b) General rule for allocating ADSP and AGUB.
(1) Reduction in the amount of consideration for Class I assets.
(2) Other assets.
(i) In general.
(ii) Class II assets.
(iii) Class III assets.
(iv) Class IV assets.
(v) Class V assets.
(vi) Class VI assets.
(vii) Class VII assets.
(3) Other items designated by the Internal Revenue Service.
(c) Certain limitations and other rules for allocation to an asset.
(1) Allocation not to exceed fair market value.
(2) Allocation subject to other rules.
(3) Special rule for allocating AGUB when purchasing corporation has
nonrecently purchased stock.
(i) Scope.
(ii) Determination of hypothetical purchase price.
(iii) Allocation of AGUB.
(4) Liabilities taken into account in determining amount realized on
subsequent disposition.
(d) Examples. §1.338-7 Allocation of redetermined ADSP and AGUB
among target assets.
(a) Scope.
(b) Allocation of redetermined ADSP and AGUB.
(c) Special rules for ADSP.
(1) Increases or decreases in deemed sale tax consequences taxable
notwithstanding old target ceases to exist.
(2) Procedure for transactions in which section 338(h)(10) is not
elected.
(i) Deemed sale tax consequences included in new target's return.
(ii) Carryovers and carrybacks.
(A) Loss carryovers to new target taxable years.
(B) Loss carrybacks to taxable years of old target.
(C) Credit carryovers and carrybacks.
(3) Procedure for transactions in which section 338(h)(10) is
elected.
(d) Special rules for AGUB.
(1) Effect of disposition or depreciation of acquisition date
assets.
(2) Section 38 property.
(e) Examples. §1.338-8 Asset and stock consistency. (a)
Introduction.
(1) Overview.
(2) General application.
(3) Extension of the general rules.
(4) Application where certain dividends are paid.
(5) Application to foreign target affiliates.
(6) Stock consistency.
(b) Consistency for direct acquisitions.
(1) General rule.
(2) Section 338(h)(10) elections.
(c) Gain from disposition reflected in basis of target stock.
(1) General rule.
(2) Gain not reflected if section 338 election made for target.
(3) Gain reflected by reason of distributions.
(4) Controlled foreign corporations.
(5) Gain recognized outside the consolidated group.
(d) Basis of acquired assets.
(1) Carryover basis rule.
(2) Exceptions to carryover basis rule for certain assets.
(3) Exception to carryover basis rule for de minimis assets.
(4) Mitigation rule.
(i) General rule.
(ii) Time for transfer.
(e) Examples.
(1) In general.
(2) Direct acquisitions.
(f) Extension of consistency to indirect acquisitions.
(1) Introduction.
(2) General rule.
(3) Basis of acquired assets.
(4) Examples.
(g) Extension of consistency if dividends qualifying for 100 percent
dividends received deduction are paid.
(1) General rule for direct acquisitions from target.
(2) Other direct acquisitions having same effect.
(3) Indirect acquisitions.
(4) Examples.
(h) Consistency for target affiliates that are controlled foreign
corporations.
(1) In general.
(2) Income or gain resulting from asset dispositions.
(i) General rule.
(ii) Basis of controlled foreign corporation stock.
(iii) Operating rule.
(iv) Increase in asset or stock basis.
(3) Stock issued by target affiliate that is a controlled foreign
corporation.
(4) Certain distributions.
(i) General rule.
(ii) Basis of controlled foreign corporation stock.
(iii) Increase in asset or stock basis.
(5) Examples.
(i) [Reserved]
(j) Anti-avoidance rules.
(1) Extension of consistency period.
(2) Qualified stock purchase and 12-month acquisition period.
(3) Acquisitions by conduits.
(i) Asset ownership.
(A) General rule.
(B) Application of carryover basis rule.
(ii) Stock acquisitions.
(A) Purchase by conduit.
(B) Purchase of conduit by corporation.
(C) Purchase of conduit by conduit.
(4) Conduit.
(5) Existence of arrangement.
(6) Predecessor and successor.
(i) Persons.
(ii) Assets.
(7) Examples. §1.338-9 International aspects of section 338.
(a) Scope.
(b) Application of section 338 to foreign targets.
(1) In general.
(2) Ownership of FT stock on the acquisition date.
(3) Carryover FT stock.
(i) Definition.
(ii) Carryover of earnings and profits.
(iii) Cap on carryover of earnings and profits.
(iv) Post-acquisition date distribution of old FT earnings and
profits.
(v) Old FT earnings and profits unaffected by post-acquisition date
deficits.
(vi) Character of FT stock as carryover FT stock eliminated upon
disposition.
(4) Passive foreign investment company stock.
(c) Dividend treatment under section 1248(e).
(d) Allocation of foreign taxes.
(e) Operation of section 338(h)(16). [Reserved]
(f) Examples. §1.338-10 Filing of returns.
(a) Returns including tax liability from deemed asset sale.
(1) In general.
(2) Old target's final taxable year otherwise included in
consolidated return of selling group.
(i) General rule.
(ii) Separate taxable year.
(iii) Carryover and carryback of tax attributes.
(iv) Old target is a component member of purchasing corporation's
controlled group.
(3) Old target is an S corporation.
(4) Combined deemed sale return.
(i) General rule.
(ii) Gain and loss offsets.
(iii) Procedure for filing a combined return.
(iv) Consequences of filing a combined return.
(5) Deemed sale excluded from purchasing corporation's consolidated
return.
(6) Due date for old target's final return.
(i) General rule.
(ii) Application of §1.1502-76(c).
(A) In general.
(B) Deemed extension.
(C) Erroneous filing of deemed sale return.
(D) Erroneous filing of return for regular tax year.
(E) Last date for payment of tax.
(7) Examples.
(b) Waiver.
(1) Certain additions to tax.
(2) Notification.
(3) Elections or other actions required to be specified on a timely
filed return.
(i) In general.
(ii) New target in purchasing corporation's consolidated return.
(4) Examples. §1.338(h)(10)-1 Deemed asset sale and
liquidation.
(a) Scope.
(b) Definitions.
(1) Consolidated target.
(2) Selling consolidated group.
(3) Selling affiliate; affiliated target.
(4) S corporation target
(5) S corporation shareholders.
(6) Liquidation.
(c) Section 338(h)(10) election.
(1) In general.
(2) Simultaneous joint election requirement.
(3) Irrevocability.
(4) Effect of invalid election.
(d) Certain consequences of section 338(h)(10) election.
(1) P.
(2) New T.
(3) Old T--deemed sale.
(i) In general.
(ii) Tiered targets.
(4) Old T and selling consolidated group, selling affiliate, or S
corporation shareholders--deemed liquidation; tax characterization.
(i) In general.
(ii) Tiered targets.
(5) Selling consolidated group, selling affiliate, or S corporation
shareholders.
(i) In general.
(ii) Basis and holding period of T stock not acquired.
(iii) T stock sale.
(6) Nonselling minority shareholders other than nonselling S
corporation shareholders.
(i) In general.
(ii) T stock sale.
(iii) T stock not acquired.
(7) Consolidated return of selling consolidated group.
(8) Availability of the section 453 installment method.
(i) In deemed asset sale.
(ii) In deemed liquidation.
(9) Treatment consistent with an actual asset sale.
(e) Examples.
(f) Inapplicability of provisions.
(g) Required information. §1.338(i)-1 Effective dates.
§1.338-1 General principles; status of old target and new
target.
(a) In general--(1) Deemed transaction. Elections are available
under section 338 when a purchasing corporation acquires the stock
of another corporation (the target) in a qualified stock purchase.
One type of election, under section 338(g), is available to the
purchasing corporation. Another type of election, under section
338(h)(10), is, in more limited circumstances, available jointly to
the purchasing corporation and the sellers of the stock. (Rules
concerning eligibility for these elections are contained in
§§1.338-2, 1.338-3, and 1.338(h)(10)-1.) Although target
is a single corporation under corporate law, if a section 338
election is made, then two separate corporations, old target and new
target, generally are considered to exist for purposes of subtitle A
of the Internal Revenue Code. Old target is treated as transferring
all of its assets to an unrelated person in exchange for
consideration that includes the discharge of its liabilities (see
§1.1001-2(a)), and new target is treated as acquiring all of
its assets from an unrelated person in exchange for consideration
that includes the assumption of those liabilities. (Such transaction
is, without regard to its characterization for Federal income tax
purposes, referred to as the deemed asset sale and the income tax
consequences thereof as the deemed sale tax consequences.) If a
section 338(h)(10) election is made, old target is deemed to
liquidate following the deemed asset sale.
(2) Application of other rules of law. Other rules of law apply to
determine the tax consequences to the parties as if they had
actually engaged in the transactions deemed to occur under section
338 and the regulations thereunder except to the extent otherwise
provided in those regulations. See also §1.338- 6(c)(2). Other
rules of law may characterize the transaction as something other
than or in addition to a sale and purchase of assets; however, the
transaction between old and new target must be a taxable
transaction. For example, if target is an insurance company for
which a section 338 election is made, the deemed asset sale would be
characterized and taxed as an assumption- reinsurance transaction
under applicable Federal income tax law. See §1.817- 4(d).
(3) Overview. Definitions and special nomenclature and rules for
making the section 338 election are provided in §1.338-2.
Qualification for the section 338 election is addressed in
§1.338-3. The amount for which old target is treated as selling
all of its assets (the aggregate deemed sale price, or ADSP) is
addressed in §1.338-4. The amount for which new target is
deemed to have purchased all its assets (the adjusted grossed-up
basis, or AGUB) is addressed in §1.338-5. Section 1.338-6
addresses allocation both of ADSP among the assets old target is
deemed to have sold and of AGUB among the assets new target is
deemed to have purchased. Section 1.338-7 addresses allocation of
ADSP or AGUB when those amounts subsequently change. Asset and stock
consistency are addressed in §1.338-8. International aspects of
section 338 are covered in §1.338-9. Rules for the filing of
returns are provided in §1.338-10. Eligibility for and
treatment of section 338(h)(10) elections is addressed in
§1.338(h)(10)-1.
(b) Treatment of target under other provisions of the Internal
Revenue Code--(1) General rule for subtitle A. Except as provided in
this section, new target is treated as a new corporation that is
unrelated to old target for purposes of subtitle A of the Internal
Revenue Code. Thus--
(i) New target is not considered related to old target for
purposes of section 168 and may make new elections under section 168
without taking into account the elections made by old target; and
(ii) New target may adopt, without obtaining prior approval from
the Commissioner, any taxable year that meets the requirements of
section 441 and any method of accounting that meets the requirements
of section 446. Notwithstanding §1.441-1T(b)(2), a new target
may adopt a taxable year on or before the last day for making the
election under section 338 by filing its first return for the
desired taxable year on or before that date.
(2) Exceptions for subtitle A. New target and old target are
treated as the same corporation for purposes of--
(i) The rules applicable to employee benefit plans (including those
plans described in sections 79, 104, 105, 106, 125, 127, 129, 132,
137, and 220), qualified pension, profit-sharing, stock bonus and
annuity plans (sections 401(a) and 403(a)), simplified employee
pensions (section 408(k)), tax qualified stock option plans
(sections 422 and 423), welfare benefit funds (sections 419, 419A,
512(a)(3), and 4976), and voluntary employee benefit associations
(section 501(c)(9) and the regulations thereunder);
(ii) Sections 1311 through 1314 (relating to the mitigation of the
effect of limitations), if a section 338(h)(10) election is not made
for target;
(iii) Section 108(e)(5) (relating to the reduction of purchase
money debt);
(iv) Section 45A (relating to the Indian Employment Credit),
section 51 (relating to the Work Opportunity Credit), section 51A
(relating to the Welfare to Work Credit), and section 1396 (relating
to the Empowerment Zone Act);
(v) Sections 401(h) and 420 (relating to medical benefits for
retirees);
(vi) Section 414 (relating to definitions and special rules); and
(vii) Any other provision designated in the Internal Revenue
Bulletin by the Internal Revenue Service. See §601.601(d)(2)
(ii) of this chapter. See, for example, §1.1001-3(e)(4)(i)(F)
providing that an election under section 338 does not result in the
substitution of a new obligor on target's debt.
(3) General rule for other provisions of the Internal Revenue
Code. Except as provided in the regulations under section 338 or in
the Internal Revenue Bulletin by the Internal Revenue Service (see
§601.601(d)(2)(ii) of this chapter), new target is treated as a
continuation of old target for purposes other than subtitle A of the
Internal Revenue Code. For example--
(i) New target is liable for old target's Federal income tax
liabilities, including the tax liability for the deemed sale tax
consequences and those tax liabilities of the other members of any
consolidated group that included old target that are attributable to
taxable years in which those corporations and old target joined in
the same consolidated return (see §1.1502-6(a));
(ii) Wages earned by the employees of old target are considered
wages earned by such employees from new target for purposes of
sections 3101 and 3111 (Federal Insurance Contributions Act) and
section 3301 (Federal Unemployment Tax Act); and
(iii) Old target and new target must use the same employer
identification number.
(c) Anti-abuse rule--
(1) In general. The rules of this paragraph (c) apply for purposes
of applying the residual method as provided for under the
regulations under sections 338 and 1060. The Commissioner is
authorized to treat any property (including cash) transferred by old
target in connection with the transactions resulting in the
application of the residual method (and not held by target at the
close of the acquisition date) as, nonetheless, property of target
at the close of the acquisition date if the property so transferred
is, within 24 months after the deemed asset sale, owned by new
target, or is owned, directly or indirectly, by a member of the
affiliated group of which new target is a member and continues after
the acquisition date to be held or used primarily in connection with
one or more of the activities of new target. In addition, the
Commissioner is authorized to treat any property (including cash)
transferred to old target in connection with the transactions
resulting in the application of the residual method (and held by
target at the close of the acquisition date) as, nonetheless, not
being property of target at the close of the acquisition date if the
property so transferred is, within 24 months after the deemed asset
sale, not owned by new target but owned, directly or indirectly, by
a member of the affiliated group of which new target is a member, or
owned by new target but held or used primarily in connection with an
activity conducted, directly or indirectly, by another member of the
affiliated group of which new target is a member in combination with
other property retained by or acquired, directly or indirectly, from
the transferor of the property (or a member of the same affiliated
group) to old target. For purposes of this paragraph (c)(1), an
interest in an entity is considered held or used in connection with
an activity if property of the entity is so held or used. The
authority of the Commissioner under this paragraph (c)(1) includes
the making of any appropriate correlative adjustments (avoiding, to
the extent possible, the duplication or omission of any item of
income, gain, loss, deduction, or basis).
(2) Examples. The following examples illustrate this paragraph
(c): Example 1. Prior to a qualified stock purchase under section
338, target transfers one of its assets to a related party. The
purchasing corporation then purchases the target stock and also
purchases the transferred asset from the related party. After its
purchase of target, the purchasing corporation and target are
members of the same affiliated group. A section 338 election is
made. Under an arrangement with the purchaser, the separately
transferred asset is used primarily in connection with target's
activities. Applying the anti-abuse rule of this paragraph (c),
the Commissioner may consider target to own the transferred asset
for purposes of applying the residual method under section 338.
Example 2. T owns all the stock of T1. T1 leases intellectual
property to T, which T uses in connection with its own activities.
P, a purchasing corporation, wishes to buy the T-T1 chain of
corporations. P, in connection with its planned purchase of the T
stock, contracts to consummate a purchase of all the stock of T1 on
March 1 and of all the stock of T on March 2. Section 338 elections
are thereafter made for both T and T1. Immediately after the
purchases, P, T and T1 are members of the same affiliated group. T
continues to lease the intellectual property from T1 and that is the
primary use of the intellectual property. Thus, an asset of T, the
T1 stock, was removed from T 's own assets prior to the qualified
stock purchase of the T stock, T1's own assets are used after the
deemed asset sale in connection with T's own activities, and the T1
stock is after the deemed asset sale owned by P, a member of the
same affiliated group of which T is a member. Applying the anti-
abuse rule of this paragraph (c), the Commissioner may, for purposes
of application of the residual method under section 338 both to T
and to T1, consider P to have bought only the stock of T, with T at
the time of the qualified stock purchases of both T and T1 (the
qualified stock purchase of T1 being triggered by the deemed sale
under section 338 of T's assets) owning T1. The Commissioner
accordingly would allocate consideration to T's assets as though the
T1 stock were one of those assets, and then allocate consideration
within T1 based on the amount allocated to the T1 stock at the T
level.
(d) Next day rule for post-closing transactions. If a target
corporation for which an election under section 338 is made engages
in a transaction outside the ordinary course of business on the
acquisition date after the event resulting in the qualified stock
purchase of the target or a higher tier corporation, the target and
all persons related thereto (either before or after the qualified
stock purchase) under section 267(b) or section 707 must treat the
transaction for all Federal income tax purposes as occurring at the
beginning of the day following the transaction and after the deemed
purchase by new target. §1.338-2 Nomenclature and definitions;
mechanics of the section 338 election.
(a) Scope. This section prescribes rules relating to elections
under section 338.
(b) Nomenclature. For purposes of the regulations under section
338 (except as otherwise provided):
(1) T is a domestic target corporation that has only one class of
stock outstanding. Old T refers to T for periods ending on or before
the close of T's acquisition date; new T refers to T for subsequent
periods.
(2) P is the purchasing corporation.
(3) The P group is an affiliated group of which P is a member.
(4) P1, P2, etc., are domestic corporations that are members of
the P group.
(5) T1, T2, etc., are domestic corporations that are target
affiliates of T.
These corporations (T1, T2, etc.) have only one class of stock
outstanding and may also be targets.
(6) S is a domestic corporation (unrelated to P and B) that owns T
prior to the purchase of T by P. (S is referred to in cases in which
it is appropriate to consider the effects of having all of the
outstanding stock of T owned by a domestic corporation.)
(7) A, a U.S. citizen or resident, is an individual (unrelated to
P and B) who owns T prior to the purchase of T by P. (A is referred
to in cases in which it is appropriate to consider the effects of
having all of the outstanding stock of T owned by an individual who
is a U.S. citizen or resident. Ownership of T by A and ownership of
T by S are mutually exclusive circumstances.)
(8) B, a U.S. citizen or resident, is an individual (unrelated to
T, S, and A) who owns the stock of P.
(9) F, used as a prefix with the other terms in this paragraph
(b), connotes foreign, rather than domestic, status. For example, FT
is a foreign corporation (as defined in section 7701(a)(5)) and FA
is an individual other than a U.S. citizen or resident.
(10) CFC, used as a prefix with the other terms in this paragraph
(b) referring to a corporation, connotes a controlled foreign
corporation (as defined in section 957, taking into account section
953(c)). A corporation identified with the prefix F may be a
controlled foreign corporation. (The prefix CFC is used when the
corporation's status as a controlled foreign corporation is
significant.)
(c) Definitions. For purposes of the regulations under section 338
(except as otherwise provided):
(1) Acquisition date. The term acquisition date has the same
meaning as in section 338(h)(2).
(2) Acquisition date assets. Acquisition date assets are the
assets of the target held at the beginning of the day after the
acquisition date (but see §1.338- 1(d) (regarding certain
transactions on the acquisition date)).
(3) Affiliated group. The term affiliated group has the same
meaning as in section 338(h)(5). Corporations are affiliated on any
day they are members of the same affiliated group.
(4) Common parent. The term common parent has the same meaning as
in section 1504.
(5) Consistency period. The consistency period is the period
described in section 338(h)(4)(A) unless extended pursuant to
§1.338-8(j)(1).
(6) Deemed asset sale. The deemed asset sale is the transaction
described in §1.338-1(a)(1) that is deemed to occur for
purposes of subtitle A of the Internal Revenue Code if a section 338
election is made.
(7) Deemed sale tax consequences. Deemed sale tax consequences
refers to, in the aggregate, the Federal income tax consequences
(generally, the income, gain, deduction, and loss) of the deemed
asset sale. Deemed sale tax consequences also refers to the Federal
income tax consequences of the transfer of a particular asset in the
deemed asset sale.
(8) Deemed sale return. The deemed sale return is the return on
which target's deemed sale tax consequences are reported that does
not include any other items of target. Target files a deemed sale
return when a section 338 election (but not a section 338(h)(10)
election) is filed for target and target is a member of a selling
group (defined in paragraph (c)(16) of this section) that files a
consolidated return for the period that includes the acquisition
date. See §1.338-10. If target is an S corporation for the
period that ends on the day before the acquisition date and a
section 338 election (but not a section 338(h)(10) election) is
filed for target, see §1.338-10(a)(3).
(9) Domestic corporation. A domestic corporation is a
corporation--
(i) That is domestic within the meaning of section 7701(a)(4) or
that is treated as domestic for purposes of subtitle A of the
Internal Revenue Code (e.g., to which an election under section
953(d) or 1504(d) applies); and
(ii) That is not a DISC, a corporation described in section
1248(e), or a corporation to which an election under section 936
applies.
(10) Old target's final return. Old target's final return is the
income tax return of old target for the taxable year ending at the
close of the acquisition date that includes the deemed sale tax
consequences. However, if a deemed sale return is filed for old
target, the deemed sale return is considered old target's final
return.
(11) Purchasing corporation. The term purchasing corporation has
the same meaning as in section 338(d)(1). The purchasing corporation
may also be referred to as purchaser. Unless otherwise provided, any
reference to the purchasing corporation is a reference to all
members of the affiliated group of which the purchasing corporation
is a member. See sections 338(h)(5) and (8). Also, unless otherwise
provided, any reference to the purchasing corporation is, with
respect to a deemed purchase of stock under section 338(a)(2), a
reference to new target with respect to its own deemed purchase of
stock in another target.
(12) Qualified stock purchase. The term qualified stock purchase
has the same meaning as in section 338(d)(3).
(13) Related persons. Two persons are related if stock in a
corporation owned by one of the persons would be attributed under
section 318(a) (other than section 318(a)(4)) to the other.
(14) Section 338 election. A section 338 election is an election
to apply section 338(a) to target. A section 338 election is made by
filing a statement of section 338 election pursuant to paragraph (d)
of this section. The form on which this statement is filed is
referred to in the regulations under section 338 as the Form 8023,
"Elections Under Section 338 For Corporations Making Qualified Stock
Purchases."
(15) Section 338(h)(10) election. A section 338(h)(10) election is
an election to apply section 338(h)(10) to target. A section 338(h)
(10) election is made by making a joint election for target under
§1.338(h)(10)-1 on Form 8023.
(16) Selling group. The selling group is the affiliated group (as
defined in section 1504) eligible to file a consolidated return that
includes target for the taxable period in which the acquisition date
occurs. However, a selling group is not an affiliated group of which
target is the common parent on the acquisition date.
(17) Target; old target; new target. Target is the target
corporation as defined in section 338(d)(2). Old target refers to
target for periods ending on or before the close of target's
acquisition date. New target refers to target for subsequent
periods.
(18) Target affiliate. The term target affiliate has the same
meaning as in section 338(h)(6) (applied without section 338(h)(6)
(B)(i)). Thus, a corporation described in section 338(h)(6)(B)(i) is
considered a target affiliate for all purposes of section 338. If a
target affiliate is acquired in a qualified stock purchase, it is
also a target.
(19) 12-month acquisition period. The 12-month acquisition period
is the period described in section 338(h)(1), unless extended
pursuant to §1.338- 8(j)(2).
(d) Time and manner of making election. The purchasing corporation
makes a section 338 election for target by filing a statement of
section 338 election on Form 8023 in accordance with the
instructions to the form. The section 338 election must be made not
later than the 15th day of the 9th month beginning after the month
in which the acquisition date occurs. A section 338 election is
irrevocable. See §1.338(h)(10)-1(c)(2) for section 338(h)(10)
elections.
(e) Special rules for foreign corporations or DISCs--(1) Elections
by certain foreign purchasing corporations--
(i) General rule. A qualifying foreign purchasing corporation is not
required to file a statement of section 338 election for a
qualifying foreign target before the earlier of 3 years after the
acquisition date and the 180th day after the close of the purchasing
corporation's taxable year within which a triggering event occurs.
(ii) Qualifying foreign purchasing corporation. A purchasing
corporation is a qualifying foreign purchasing corporation only if,
during the acquisition period of a qualifying foreign target, all
the corporations in the purchasing corporation's affiliated group
are foreign corporations that are not subject to United States tax.
(iii) Qualifying foreign target. A target is a qualifying foreign
target only if target and its target affiliates are foreign
corporations that, during target's acquisition period, are not
subject to United States tax (and will not become subject to United
States tax during such period because of a section 338 election). A
target affiliate is taken into account for purposes of the preceding
sentence only if, during target's 12-month acquisition period, it is
or becomes a member of the affiliated group that includes the
purchasing corporation.
(iv) Triggering event. A triggering event occurs in the taxable
year of the qualifying foreign purchasing corporation in which
either that corporation or any corporation in its affiliated group
becomes subject to United States tax.
(v) Subject to United States tax. For purposes of this paragraph
(e)(1), a foreign corporation is considered subject to United States
tax--
(A) For the taxable year for which that corporation is required
under §1.6012-2(g) (other than §1.6012-2(g)(2)(i)(B)(2))
to file a United States income tax return; or
(B) For the period during which that corporation is a controlled
foreign corporation, a passive foreign investment company for which
an election under section 1295 is in effect, a foreign investment
company, or a foreign corporation the stock ownership of which is
described in section 552(a)(2).
(2) Acquisition period. For purposes of this paragraph (e), the
term acquisition period means the period beginning on the first day
of the 12-month acquisition period and ending on the acquisition
date.
(3) Statement of section 338 election may be filed by United States
shareholders in certain cases. The United States shareholders (as
defined in section 951(b)) of a foreign purchasing corporation that
is a controlled foreign corporation (as defined in section 957
(taking into account section 953(c))) may file a statement of
section 338 election on behalf of the purchasing corporation if the
purchasing corporation is not required under §1.6012-2(g)
(other than §1.6012-2(g)(2)(i)(B)(2)) to file a United States
income tax return for its taxable year that includes the acquisition
date. Form 8023 must be filed as described in the form and its
instructions and also must be attached to the Form 5471,
"Information Returns Of U.S. Persons With Respect To Certain Foreign
Corporations," filed with respect to the purchasing corporation by
each United States shareholder for the purchasing corporation's
taxable year that includes the acquisition date (or, if paragraph
(e)(1)(i) of this section applies to the election, for the
purchasing corporation's taxable year within which it becomes a
controlled foreign corporation). The provisions of §1.964-1(c)
(including §1.964- 1(c)(7)) do not apply to an election made by
the United States shareholders. (4) Notice requirement for U.S.
persons holding stock in foreign target--
(i) General rule. If a target subject to a section 338 election was
a controlled foreign corporation, a passive foreign investment
company, or a foreign personal holding company at any time during
the portion of its taxable year that ends on its acquisition date,
the purchasing corporation must deliver written notice of the
election (and a copy of Form 8023, its attachments and instructions)
to--
(A) Each U.S. person (other than a member of the affiliated group
of which the purchasing corporation is a member (the purchasing
group member)) that, on the acquisition date of the foreign target,
holds stock in the foreign target; and
(B) Each U.S. person (other than a purchasing group member) that
sells stock in the foreign target to a purchasing group member
during the foreign target's 12-month acquisition period.
(ii) Limitation. The notice requirement of this paragraph (e)(4)
applies only where the section 338 election for the foreign target
affects income, gain, loss, deduction, or credit of the U.S. person
described in paragraph (e)(4)(i) of this section under section 551,
951, 1248, or 1293. (iii) Form of notice. The notice to U.S. persons
must be identified prominently as a notice of section 338 election
and must--
(A) Contain the name, address, and employer identification number
(if any) of, and the country (and, if relevant, the lesser political
subdivision) under the laws of which are organized the purchasing
corporation and the relevant target (i.e., the target the stock of
which the particular U.S. person held or sold under the
circumstances described in paragraph (e)(4)(i) of this section);
(B) Identify those corporations as the purchasing corporation and
the foreign target, respectively; and
(C) Contain the following declaration (or a substantially similar
declaration):
THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION
UNDER SECTION 338 FOR THE ABOVE CITED FOREIGN
TARGET THE STOCK OF WHICH YOU EITHER HELD OR SOLD
UNDER THE CIRCUMSTANCES DESCRIBED IN TREASURY
REGULATIONS SECTION 1.338-2(e)(4). FOR POSSIBLE
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
UNDER SECTION 551, 951, 1248, OR 1293 OF THE INTERNAL
REVENUE CODE OF 1986 THAT MAY APPLY TO YOU, SEE
TREASURY REGULATIONS SECTION 1.338-9(b). YOU MAY BE
REQUIRED TO ATTACH THE INFORMATION ATTACHED TO
THIS NOTICE TO CERTAIN RETURNS.
(iv) Timing of notice. The notice required by this paragraph (e)
(4) must be delivered to the U.S. person on or before the later of
the 120th day after the acquisition date of the particular target or
the day on which Form 8023 is filed. The notice is considered
delivered on the date it is mailed to the proper address (or an
address similar enough to complete delivery), unless the date it is
mailed cannot be reasonably determined. The date of mailing will be
determined under the rules of section 7502. For example, the date of
mailing is the date of U.S. postmark or the applicable date recorded
or marked by a designated delivery service.
(v) Consequence of failure to comply. A statement of section 338
election is not valid if timely notice is not given to one or more
U.S. persons described in this paragraph (e)(4). If the form of
notice fails to comply with all requirements of this paragraph (e)
(4), the section 338 election is valid, but the waiver rule of
§1.338-10(b)(1) does not apply.
(vi) Good faith effort to comply. The purchasing corporation will
be considered to have complied with this paragraph (e)(4), even
though it failed to provide notice or provide timely notice to each
person described in this paragraph (e)(4), if the Commissioner
determines that the purchasing corporation made a good faith effort
to identify and provide timely notice to those U.S. persons.
§1.338-3 Qualification for the section 338 election.
(a) Scope. This section provides rules on whether certain
acquisitions of stock are qualified stock purchases and on other
miscellaneous issues under section 338.
(b) Rules relating to qualified stock purchases--(1) Purchasing
corporation requirement. An individual cannot make a qualified stock
purchase of target. Section 338(d)(3) requires, as a condition of a
qualified stock purchase, that a corporation purchase the stock of
target. If an individual forms a corporation (new P) to acquire
target stock, new P can make a qualified stock purchase of target if
new P is considered for tax purposes to purchase the target stock.
Facts that may indicate that new P does not purchase the target
stock include new P's merging downstream into target, liquidating,
or otherwise disposing of the target stock following the purported
qualified stock purchase.
(2) Purchase. The term purchase has the same meaning as in section
338(h)(3). Stock in a target (or target affiliate) may be considered
purchased if, under general principles of tax law, the purchasing
corporation is considered to own stock of the target (or target
affiliate) meeting the requirements of section 1504(a)(2),
notwithstanding that no amount may be paid for (or allocated to) the
stock.
(3) Acquisitions of stock from related corporations--
(i) In general. Stock acquired by a purchasing corporation from a
related corporation (R) is generally not considered acquired by
purchase. See section 338(h)(3)(A)(iii).
(ii) Time for testing relationship. For purposes of section 338(h)
(3)(A)(iii), a purchasing corporation is treated as related to
another person if the relationship specified in section 338(h)(3)(A)
(iii) exists--
(A) In the case of a single transaction, immediately after the
purchase of target stock;
(B) In the case of a series of acquisitions otherwise constituting
a qualified stock purchase within the meaning of section 338(d)(3),
immediately after the last acquisition in such series; and
(C) In the case of a series of transactions effected pursuant to
an integrated plan to dispose of target stock, immediately after the
last transaction in such series.
(iii) Cases where section 338(h)(3)(C) applies--acquisitions
treated as purchases. If section 338(h)(3)(C) applies and the
purchasing corporation is treated as acquiring stock by purchase
from R, solely for purposes of determining when the stock is
considered acquired, target stock acquired from R is considered to
have been acquired by the purchasing corporation on the day on which
the purchasing corporation is first considered to own that stock
under section 318(a) (other than section 318(a)(4)). (iv) Examples.
The following examples illustrate this paragraph (b)(3): Example 1.
(i) S is the parent of a group of corporations that are engaged in
various businesses. Prior to January 1, Year 1, S decided to
discontinue its involvement in one line of business. To accomplish
this, S forms a new corporation, Newco, with a nominal amount of
cash. Shortly thereafter, on January 1, Year 1, S transfers all the
stock of the subsidiary conducting the unwanted business (T) to
Newco in exchange for 100 shares of Newco common stock and a Newco
promissory note. Prior to January 1, Year 1, S and Underwriter (U)
had entered into a binding agreement pursuant to which U would
purchase 60 shares of Newco common stock from S and then sell those
shares in an Initial Public Offering (IPO). On January 6, Year 1,
the IPO closes.
(ii) Newco's acquisition of T stock is one of a series of
transactions undertaken pursuant to one integrated plan. The series
of transactions ends with the closing of the IPO and the transfer of
all the shares of stock in accordance with the agreements.
Immediately after the last transaction effected pursuant to the
plan, S owns 40 percent of Newco, which does not give rise to a
relationship described in section 338(h)(3)(A)(iii). See
§1.338-3(b)(3)(ii)(C). Accordingly, S and Newco are not related
for purposes of section 338(h)(3)(A)(iii).
(iii) Further, because Newco's basis in the T stock is not
determined by reference to S's basis in the T stock and because the
transaction is not an exchange to which section 351, 354, 355, or
356 applies, Newco's acquisition of the T stock is a purchase within
the meaning of section 338(h)(3).
Example 2.
(i) On January 1 of Year 1, P purchases 75 percent in value of the R
stock. On that date, R owns 4 of the 100 shares of T stock. On June
1 of Year 1, R acquires an additional 16 shares of T stock. On
December 1 of Year 1, P purchases 70 shares of T stock from an
unrelated person and 12 of the 20 shares of T stock held by R. (ii)
Of the 12 shares of T stock purchased by P from R on December 1 of
Year 1, 3 of those shares are deemed to have been acquired by P on
January 1 of Year 1, the date on which 3 of the 4 shares of T stock
held by R on that date were first considered owned by P under
section 318(a)(2)(C) (i.e., 4 ÷ .75). The remaining 9 shares
of T stock purchased by P from R on December 1 of Year 1 are deemed
to have been acquired by P on June 1 of Year 1, the date on which an
additional 12 of the 20 shares of T stock owned by R on that date
were first considered owned by P under section 318(a)(2)(C) (i.e.,
(20 ÷ .75) -3). Because stock acquisitions by P sufficient
for a qualified stock purchase of T occur within a 12-month period
(i.e., 3 shares constructively on January 1 of Year 1, 9 shares
constructively on June 1 of Year 1, and 70 shares actually on
December 1 of Year 1), a qualified stock purchase is made on
December 1 of Year 1. Example 3.
(i) On February 1 of Year 1, P acquires 25 percent in value of the R
stock from B (the sole shareholder of P). That R stock is not
acquired by purchase. See section 338(h)(3)(A)(iii). On that date, R
owns 4 of the 100 shares of T stock. On June 1 of Year 1, P
purchases an additional 25 percent in value of the R stock, and on
January 1 of Year 2, P purchases another 25 percent in value of the
R stock. On June 1 of Year 2, R acquires an additional 16 shares of
the T stock. On December 1 of Year 2, P purchases 68 shares of the T
stock from an unrelated person and 12 of the 20 shares of the T
stock held by R.
(ii) Of the 12 shares of the T stock purchased by P from R on
December 1 of Year 2, 2 of those shares are deemed to have been
acquired by P on June 1 of Year 1, the date on which 2 of the 4
shares of the T stock held by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e., 4 ÷ .5). For
purposes of this attribution, the R stock need not be acquired by P
by purchase. See section 338(h)(1). (By contrast, the acquisition of
the T stock by P from R does not qualify as a purchase unless P has
acquired at least 50 percent in value of the R stock by purchase.
Section 338(h)(3)(C)(i).) Of the remaining 10 shares of the T stock
purchased by P from R on December 1 of Year 2, 1 of those shares is
deemed to have been acquired by P on January 1 of Year 2, the date
on which an additional 1 share of the 4 shares of the T stock held
by R on that date was first considered owned by P under section
318(a)(2)(C) (i.e., (4 ÷ .75) -2). The remaining 9 shares of
the T stock purchased by P from R on December 1 of Year 2, are
deemed to have been acquired by P on June 1 of Year 2, the date on
which an additional 12 shares of the T stock held by R on that date
were first considered owned by P under section 318(a)(2)(C) (i.e.,
(20 ÷ .75) -3). Because a qualified stock purchase of T by P
is made on December 1 of Year 2 only if all 12 shares of the T stock
purchased by P from R on that date are considered acquired during a
12-month period ending on that date (so that, in conjunction with
the 68 shares of the T stock P purchased on that date from the
unrelated person, 80 of T's 100 shares are acquired by P during a
12-month period) and because 2 of those 12 shares are considered to
have been acquired by P more than 12 months before December 1 of
Year 2 (i.e., on June 1 of Year 1), a qualified stock purchase is
not made. (Under §1.338-8(j)(2), for purposes of applying the
consistency rules, P is treated as making a qualified stock purchase
of T if, pursuant to an arrangement, P purchases T stock satisfying
the requirements of section 1504(a)(2) over a period of more than 12
months.)
Example 4. Assume the same facts as in Example 3, except that on
February 1 of Year 1, P acquires 25 percent in value of the R stock
by purchase. The result is the same as in Example 3. (4) Acquisition
date for tiered targets--
(i) Stock sold in deemed asset sale. If an election under section
338 is made for target, old target is deemed to sell target's assets
and new target is deemed to acquire those assets. Under section
338(h)(3)(B), new target's deemed purchase of stock of another
corporation is a purchase for purposes of section 338(d)(3) on the
acquisition date of target. If new target's deemed purchase causes a
qualified stock purchase of the other corporation and if a section
338 election is made for the other corporation, the acquisition date
for the other corporation is the same as the acquisition date of
target. However, the deemed sale and purchase of the other
corporation's assets is considered to take place after the deemed
sale and purchase of target's assets.
(ii) Example. The following example illustrates this paragraph (b)
(4): Example. A owns all of the T stock. T owns 50 of the 100
shares of X stock. The other 50 shares of X stock are owned by
corporation Y, which is unrelated to A, T, or P. On January 1 of
Year 1, P makes a qualified stock purchase of T from A and makes a
section 338 election for T. On December 1 of Year 1, P purchases
the 50 shares of X stock held by Y. A qualified stock purchase of
X is made on December 1 of Year 1, because the deemed purchase of
50 shares of X stock by new T because of the section 338 election
for T and the actual purchase of 50 shares of X stock by P are
treated as purchases made by one corporation. Section 338(h)(8).
For purposes of determining whether those purchases occur within a
12-month acquisition period as required by section 338(d)(3), T is
deemed to purchase its X stock on T's acquisition date, i.e.,
January 1 of Year 1.
(5) Effect of redemptions--
(i) General rule. Except as provided in this paragraph (b)(5), a
qualified stock purchase is made on the first day on which the
percentage ownership requirements of section 338(d)(3) are satisfied
by reference to target stock that is both--
(A) Held on that day by the purchasing corporation; and
(B) Purchased by the purchasing corporation during the 12-month
period
ending on that day. (ii) Redemptions from persons unrelated to the
purchasing corporation. Target stock redemptions from persons
unrelated to the purchasing corporation that occur during the 12-
month acquisition period are taken into account as
reductions in target's outstanding stock for purposes of determining
whether target stock purchased by the purchasing corporation in the
12-month acquisition period satisfies the percentage ownership
requirements of section 338(d)(3).
(iii) Redemptions from the purchasing corporation or related
persons during 12-month acquisition period--
(A) General rule. For purposes of the percentage ownership
requirements of section 338(d)(3), a redemption of target stock
during the 12-month acquisition period from the purchasing
corporation or from any person related to the purchasing corporation
is not taken into account as a reduction in target's outstanding
stock.
(B) Exception for certain redemptions from related corporations. A
redemption of target stock during the 12-month acquisition period
from a corporation related to the purchasing corporation is taken
into account as a reduction in target's outstanding stock to the
extent that the redeemed stock would have been considered purchased
by the purchasing corporation (because of section 338(h)(3)(C))
during the 12-month acquisition period if the redeemed stock had
been acquired by the purchasing corporation from the related
corporation on the day of the redemption. See paragraph (b)(3) of
this section.
(iv) Examples. The following examples illustrate this paragraph (b)
(5): Example 1. QSP on stock purchase date; redemption from
unrelated person during 12-month period. A owns all 100 shares of T
stock. On January 1 of Year 1, P purchases 40 shares of the T stock
from A. On July 1 of Year 1, T redeems 25 shares from A. On
December 1 of Year 1, P purchases 20 shares of the T stock from A.
P makes a qualified stock purchase of T on December 1 of Year 1,
because the 60 shares of T stock purchased by P within the 12-month
period ending on that date satisfy the 80-percent ownership
requirements of section 338(d)(3) (i.e., 60/75 shares), determined
by taking into account the redemption of 25 shares.
Example 2. QSP on stock redemption date; redemption from unrelated
person during 12-month period. The facts are the same as in Example
1, except that P purchases 60 shares of T stock on January 1 of Year
1 and none on December 1 of Year 1. P makes a qualified stock
purchase of T on July 1 of Year 1, because that is the first day on
which the T stock purchased by P within the preceding 12-month
period satisfies the 80-percent ownership requirements of section
338(d)(3) (i.e., 60/75 shares), determined by taking into account
the redemption of 25 shares.
Example 3. Redemption from purchasing corporation not taken into
account. On December 15 of Year 1, T redeems 30 percent of its stock
from P. The redeemed stock was held by P for several years and
constituted P's total interest in T. On December 1 of Year 2, P
purchases the remaining T stock from A. P does not make a qualified
stock purchase of T on December 1 of Year 2. For purposes of the 80-
percent ownership requirements of section 338(d)(3), the redemption
of P's T stock on December 15 of Year 1 is not taken into account as
a reduction in T's outstanding stock.
Example 4. Redemption from related person taken into account. On
January 1 of Year 1, P purchases 60 of the 100 shares of X stock. On
that date, X owns 40 of the 100 shares of T stock. On April 1 of
Year 1, T redeems X's T stock and P purchases the remaining 60
shares of T stock from an unrelated person. For purposes of the 80-
percent ownership requirements of section 338(d)(3), the redemption
of the T stock from X (a person related to P) is taken into account
as a reduction in T's outstanding stock. If P had purchased the 40
redeemed shares from X on April 1 of Year 1, all 40 of the shares
would have been considered purchased (because of section 338(h)(3)
(C)(i)) during the 12- month period ending on April 1 of Year 1 (24
of the 40 shares would have been considered purchased by P on
January 1 of Year 1 and the remaining 16 shares would have been
considered purchased by P on April 1 of Year 1). See paragraph (b)
(3) of this section. Accordingly, P makes a qualified stock purchase
of T on April 1 of Year 1, because the 60 shares of T stock
purchased by P on that date satisfy the 80-percent ownership
requirements of section 338(d)(3) (i.e., 60/60 shares), determined
by taking into account the redemption of 40 shares.
(c) Effect of post-acquisition events on eligibility for section 338
election--
(1) Post-acquisition elimination of target.
(i) The purchasing corporation may
make an election under section 338 for target even though target is
liquidated on or after the acquisition date. If target liquidates on
the acquisition date, the liquidation is considered to occur on the
following day and immediately after new target's deemed purchase of
assets. The purchasing corporation may also make an election under
section 338 for target even though target is merged into another
corporation, or otherwise disposed of by the purchasing corporation
provided that, under the facts and circumstances, the purchasing
corporation is considered for tax purposes as the purchaser of the
target stock.
(ii) The following examples illustrate this paragraph (c)(1):
Example 1. On January 1 of Year 1, P purchases 100 percent of the
outstanding common stock of T. On June 1 of Year 1, P sells the T
stock to an unrelated person. Assuming that P is considered for tax
purposes as the purchaser of the T stock, P remains eligible, after
June 1 of Year 1, to make a section 338 election for T that results
in a deemed asset sale of T's assets on January 1 of Year 1.
Example 2. On January 1 of Year 1, P makes a qualified stock
purchase of T. On that date, T owns the stock of T1. On March 1 of
Year 1, T sells the T1 stock to an unrelated person. On April 1 of
Year 1, P makes a section 338 election for T. Notwithstanding that
the T1 stock was sold on March 1 of Year 1, the section 338 election
for T on April 1 of Year 1 results in a qualified stock purchase by
T of T1 on January 1 of Year 1. See paragraph (b)(4)(i) of this
section.
(2) Post-acquisition elimination of the purchasing corporation. An
election under section 338 may be made for target after the
acquisition of assets of the purchasing corporation by another
corporation in a transaction described in section 381(a), provided
that the purchasing corporation is considered for tax purposes as
the purchaser of the target stock. The acquiring corporation in the
section 381(a) transaction may make an election under section 338
for target.
(d) Consequences of post-acquisition elimination of target where
section 338 election not made--(1) Scope. The rules of this
paragraph (d) apply to the transfer of target assets to the
purchasing corporation (or another member of the same affiliated
group as the purchasing corporation) (the transferee) following a
qualified stock purchase of target stock, if the purchasing
corporation does not make a section 338 election for target.
Notwithstanding the rules of this paragraph (d), section 354(a) (and
so much of section 356 as relates to section 354) cannot apply to
any person other than the purchasing corporation or another member
of the same affiliated group as the purchasing corporation unless
the transfer of target assets is pursuant to a reorganization as
determined without regard to this paragraph (d).
(2) Continuity of interest. By virtue of section 338, in
determining whether the continuity of interest requirement of
§1.368-1(b) is satisfied on the transfer of assets from target
to the transferee, the purchasing corporation's target stock
acquired in the qualified stock purchase represents an interest on
the part of a person who was an owner of the target's business
enterprise prior to the transfer that can be continued in a
reorganization.
(3) Control requirement. By virtue of section 338, the acquisition
of target stock in the qualified stock purchase will not prevent the
purchasing corporation from qualifying as a shareholder of the
target transferor for the purpose of determining whether,
immediately after the transfer of target assets, a shareholder of
the transferor is in control of the corporation to which the assets
are transferred within the meaning of section 368(a)(1)(D).
(4) Solely for voting stock requirement. By virtue of section 338,
the acquisition of target stock in the qualified stock purchase for
consideration other than voting stock will not prevent the
subsequent transfer of target assets from satisfying the solely for
voting stock requirement for purposes of determining if the transfer
of target assets qualifies as a reorganization under section 368(a)
(1)(C).
(5) Example. The following example illustrates this paragraph (d):
Example.
(i) Facts.
P, T, and X are domestic corporations. T and X each operate a
trade or business. A and K, individuals unrelated to P, own 85 and
15 percent, respectively, of the stock of T. P owns all of the stock
of X. The total adjusted basis of T's property exceeds the sum of
T's liabilities plus the amount of liabilities to which T's property
is subject. P purchases all of A's T stock for cash in a qualified
stock purchase. P does not make an election under section 338(g)
with respect to its acquisition of T stock. Shortly after the
acquisition date, and as part of the same plan, T merges under
applicable state law into X in a transaction that, but for the
question of continuity of interest, satisfies all the requirements
of section 368(a)(1)(A). In the merger, all of T's assets are
transferred to X. P and K receive X stock in exchange for their T
stock. P intends to retain the stock of X indefinitely.
(ii) Status of transfer as a reorganization. By virtue of
section 338, for the purpose of determining whether the continuity
of interest requirement of §1.368- 1(b) is satisfied, P's T
stock acquired in the qualified stock purchase represents an
interest on the part of a person who was an owner of T's business
enterprise prior to the transfer that can be continued in a
reorganization through P's continuing ownership of X. Thus, the
continuity of interest requirement is satisfied and the merger of T
into X is a reorganization within the meaning of section 368(a)(1)
(A). Moreover, by virtue of section 338, the requirement of section
368(a)(1)(D) that a target shareholder control the transferee
immediately after the transfer is satisfied because P controls X
immediately after the transfer. In addition, all of T's assets are
transferred to X in the merger and P and K receive the X stock
exchanged therefor in pursuance of the plan of reorganization. Thus,
the merger of T into X is also a reorganization within the meaning
of section 368(a)(1)(D).
(iii) Treatment of T and X. Under section 361(a), T recognizes no
gain or loss in the merger. Under section 362(b), X's basis in the
assets received in the merger is the same as the basis of the assets
in T's hands. X succeeds to and takes into account the items of T as
provided in section 381.
(iv) Treatment of P. By virtue of section 338, the transfer of T
assets to X is a reorganization. Pursuant to that reorganization, P
exchanges its T stock solely for stock of X, a party to the
reorganization. Because P is the purchasing corporation, section 354
applies to P's exchange of T stock for X stock in the merger of T
into X. Thus, P recognizes no gain or loss on the exchange. Under
section 358, P's basis in the X stock received in the exchange is
the same as the basis of P's T stock exchanged therefor.
(v) Treatment of K. Because K is not the purchasing corporation
(or an affiliate thereof), section 354 cannot apply to K's exchange
of T stock for X stock in the merger of T into X unless the transfer
of T's assets is pursuant to a reorganization as determined without
regard to this paragraph (d). Under general principles of tax law
applicable to reorganizations, the continuity of interest
requirement is not satisfied because P's stock purchase and the
merger of T into X are pursuant to an integrated transaction in
which A, the owner of 85 percent of the stock of T, received solely
cash in exchange for A's T stock. See, e.g., §1.368-1(e)(1)(i);
Yoc Heating v. Commissioner, 61 T.C. 168 (1973); Kass v.
Commissioner, 60 T.C. 218 (1973), aff'd, 491 F.2d 749 (3d Cir.
1974). Thus, the requisite continuity of interest under
§1.368-1(b) is lacking and section 354 does not apply to K's
exchange of T stock for X stock. K recognizes gain or loss, if any,
pursuant to section 1001(c) with respect to its T stock.
§1.338-4 Aggregate deemed sale price; various aspects of
taxation of the deemed asset sale. (a) Scope. This section provides
rules under section 338(a)(1) to determine the aggregate deemed sale
price (ADSP) for target. ADSP is the amount for which old target is
deemed to have sold all of its assets in the deemed asset sale. ADSP
is allocated among target's assets in accordance with §1.338-6
to determine the amount for which each asset is deemed to have been
sold. When a subsequent increase or decrease is required under
general principles of tax law with respect to an element of ADSP,
the redetermined ADSP is allocated among target's assets in
accordance with §1.338-7. This §1.338-4 also provides
rules regarding the recognition of gain or loss on the deemed sale
of target affiliate stock. Notwithstanding section 338(h)(6)(B)(ii),
stock held by a target affiliate in a foreign corporation or in a
corporation that is a DISC or that is described in section 1248(e)
is not excluded from the operation of section 338.
(b) Determination of ADSP--(1) General rule. ADSP is the sum of--
(i) The grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock (as defined in section 338(b)(6)(A)); and
(ii) The liabilities of old target.
(2) Time and amount of ADSP--
(i) Original determination. ADSP is initially determined at the
beginning of the day after the acquisition date of target. General
principles of tax law apply in determining the timing and amount of
the elements of ADSP.
(ii) Redetermination of ADSP. ADSP is redetermined at such time
and in such amount as an increase or decrease would be required,
under general principles of tax law, for the elements of ADSP. For
example, ADSP is redetermined because of an increase or decrease in
the amount realized for recently purchased stock or because
liabilities not originally taken into account in determining ADSP
are subsequently taken into account. Increases or decreases with
respect to the elements of ADSP result in the reallocation of ADSP
among target's assets under §1.338-7.
(iii) Example. The following example illustrates this paragraph
(b)(2): Example. In Year 1, T, a manufacturer, purchases a
customized delivery truck from X with purchase money indebtedness
having a stated principal amount of $100,000. P acquires all of
the stock of T in Year 3 for $700,000 and makes a section 338
election for T. Assume T has no liabilities other than its
purchase money indebtedness to X. In Year 4, when T is neither
insolvent nor in a title 11 case, T and X agree to reduce the
amount of the purchase money indebtedness to $80,000. Assume
further that the reduction would be a purchase price reduction
under section 108(e)(5). T and X's agreement to reduce the amount
of the purchase money indebtedness would not, under general
principles of tax law that would apply if the deemed asset sale
had actually occurred, change the amount of liabilities of old
target taken into account in determining its amount realized.
Accordingly, ADSP is not redetermined at the time of the
reduction. See §1.338-5(b)(2)(iii) Example 1 for the effect
on AGUB.
(c) Grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock--(1) Determination of amount. The grossed-up amount
realized on the sale to the purchasing corporation of the purchasing
corporation's recently purchased target stock is an amount equal
to--
(i) The amount realized on the sale to the purchasing corporation
of the purchasing corporation's recently purchased target stock
determined as if the selling shareholder(s) were required to use old
target's accounting methods and characteristics and the installment
method were not available and determined without regard to the
selling costs taken into account under paragraph (c)(1)(iii) of this
section;
(ii) Divided by the percentage of target stock (by value,
determined on the acquisition date) attributable to that recently
purchased target stock; (iii) Less the selling costs incurred by the
selling shareholders in connection with the sale to the purchasing
corporation of the purchasing corporation's recently purchased
target stock that reduce their amount realized on the sale of the
stock (e.g., brokerage commissions and any similar costs to sell the
stock).
(2) Example. The following example illustrates this paragraph
(c): Example. T has two classes of stock outstanding, voting
common stock and preferred stock described in section 1504(a)(4).
On March 1 of Year 1, P purchases 40 percent of the outstanding T
stock from S1 for $500, 20 percent of the outstanding T stock
from S2 for $225, and 20 percent of the outstanding T stock from
S3 for $275. On that date, the fair market value of all the T
voting common stock is $1,250 and the preferred stock $750. S1,
S2, and S3 incur $40, $35, and $25 respectively of selling costs.
S1 continues to own the remaining 20 percent of the outstanding T
stock. The grossed-up amount realized on the sale to P of P's
recently purchased T stock is calculated as follows: The total
amount realized (without regard to selling costs) is $1,000 (500
+ 225 + 275). The percentage of T stock by value on the
acquisition date attributable to the recently purchased T stock
is 50% (1,000/(1,250 + 750)). The selling costs are $100 (40 + 35
+ 25). The grossed-up amount realized is $1,900 (1,000/.5 ! !
100).
(d) Liabilities of old target--
(1) In general. In general, the liabilities of old target are
measured as of the beginning of the day after the acquisition date.
(But see §1.338-1(d) (regarding certain transactions on the
acquisition date).) In order to be taken into account in ADSP, a
liability must be a liability of target that is properly taken into
account in amount realized under general principles of tax law that
would apply if old target had sold its assets to an unrelated person
for consideration that included the discharge of its liabilities.
See §1.1001-2(a). Such liabilities may include liabilities for
the tax consequences resulting from the deemed sale.
(2) Time and amount of liabilities. The time for taking into
account liabilities of old target in determining ADSP and the amount
of the liabilities taken into account is determined as if old target
had sold its assets to an unrelated person for consideration that
included the discharge of the liabilities by the unrelated person.
For example, if no amount of a target liability is properly taken
into account in amount realized as of the beginning of the day after
the acquisition date, the liability is not initially taken into
account in determining ADSP (although it may be taken into account
at some later date).
(e) Deemed sale tax consequences. Gain or loss on each asset in
the deemed sale is computed by reference to the ADSP allocated to
that asset. ADSP is allocated under the rules of §1.338-6.
Though deemed sale tax consequences may increase or decrease ADSP by
creating or reducing a tax liability, the amount of the tax
liability itself may be a function of the size of the deemed sale
tax consequences. Thus, these determinations may require trial and
error computations.
(f) Other rules apply in determining ADSP. ADSP may not be
applied in such a way as to contravene other applicable rules. For
example, a capital loss cannot be applied to reduce ordinary income
in calculating the tax liability on the deemed sale for purposes of
determining ADSP.
(g) Examples. The following examples illustrate this section. For
purposes of the examples in this paragraph (g), unless otherwise
stated, T is a calendar year taxpayer that files separate returns
and that has no loss, tax credit, or other carryovers to Year 1.
Depreciation for Year 1 is not taken into account. T has no
liabilities other than the Federal income tax liability resulting
from the deemed asset sale, and the T shareholders have no selling
costs. Assume that T's tax rate for any ordinary income or net
capital gain resulting from the deemed sale of assets is 34 percent
and that any capital loss is offset by capital gain. On July 1 of
Year 1, P purchases all of the stock of T and makes a section 338
election for T. The examples are as follows:
Example 1. One class.
(i) On July 1 of Year 1, T's only asset is an item of section 1245
property with an adjusted basis to T of $50,400, a recomputed basis
of $80,000, and a fair market value of $100,000. P purchases all of
the T stock for $75,000, which also equals the amount realized for
the stock determined as if the selling shareholder(s) were required
to use old target's accounting methods and characteristics. (ii)
ADSP is determined as follows (for purposes of this section (g), G
is the grossed-up amount realized on the sale to P of P's recently
purchased T stock, L is T's liabilities other than T's tax liability
for the deemed sale tax consequences, T is the applicable tax rate,
and B is the adjusted basis of the R asset deemed sold): ADSP = G +
L + T ÷ (ADSP ! ! B).
R ADSP = ($75,000/1) + $0 + .34 ÷
(ADSP ! ! $50,400) ADSP = $75,000 + .34ADSP ! !
$17,136 .66ADSP = $57,864 ADSP = $87,672.72
(iii) Because ADSP for T ($87,672.72) does not exceed the fair
market value of T's asset ($100,000), a Class V asset, T's entire
ADSP is allocated to that asset. Thus, T's deemed sale results in
$37,272.72 of taxable income (consisting of $29,600 of ordinary
income and $7,672.72 of capital gain).
(iv) The facts are the same as in paragraph (i) of this Example 1,
except that on July 1 of Year 1, P purchases only 80 of the 100
shares of T stock for
$60,000. The grossed-up amount realized on the sale to P of P's
recently purchased T stock (G) is $75,000 ($60,000/.8).
Consequently, ADSP and the deemed sale tax consequences are the same
as in paragraphs (ii) and (iii) of this Example 1.
(v) The facts are the same as in paragraph (i) of this Example 1,
except that T also has goodwill (a Class VII asset) with an
appraised value of $10,000. The results are the same as in
paragraphs (ii) and (iii) of this Example 1. Because ADSP does not
exceed the fair market value of the Class V asset, no amount is
allocated to the Class VII asset (goodwill). Example 2. More than
one class.
(i) P purchases all of the T stock for $140,000, which also equals
the amount realized for the stock determined as if the selling
shareholder(s) were required to use old target's accounting methods
and characteristics. On July 1 of Year 1, T has liabilities (not
including the tax liability for the deemed sale tax consequences) of
$50,000, cash (a Class I asset) of $10,000, actively traded
securities (a Class II asset) with a basis of $4,000 and a fair
market value of $10,000, goodwill (a Class VII asset) with a basis
of $3,000, and the following Class V assets:
Asset Basis FMV Ratio of asset FMV to total Class V FMV
Land .................... $5,000 $35,000 .14
Building.................. 10,000 50,000 .20
Equipment A (Recomputed 5,000 90,000 .36
basis $80,000) ............
Equipment B (Recomputed 10,000 75,000 .30
basis $20,000) ............
Totals........$ 30,000 $250,000 1.00
(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to
the cash and $10,000 to the actively traded securities. The amount
allocated to an asset (other than a Class VII asset) cannot exceed
its fair market value (however, the fair market value of any
property subject to nonrecourse indebtedness is treated as being not
less than the amount of such indebtedness; see §1.338-6(a)(2)).
See §1.338-6(c)(1) (relating to fair market value limitation).
(iii) The portion of ADSP allocable to the Class V assets is
preliminarily determined as follows (in the formula, the amount
allocated to the Class I assets is referred to as I and the amount
allocated to the Class II assets as II):
ADSP = (G ! (I + II)) + L + T ÷ [(II ! B ) + (ADSP ! B )]
! ! V RIIVV
ADSP = ($140,000 ! ($10,000 + $10,000)) + $50,000 + .34 ÷
[($10,000 ! ! V $4,000) + (ADSP ! ! ($5,000 + $10,000 + $5,000 +
$10,000))]
V ADSP = $161,840 + .34 ADSP VV .66 ADSP = $161,840 V
ADSP = $245,212.12 V
(iv) Because, under the preliminary calculations of ADSP, the
amount to be allocated to the Class I, II, III, IV, V, and VI assets
does not exceed their aggregate fair market value, no ADSP amount is
allocated to goodwill. Accordingly, the deemed sale of the goodwill
results in a capital loss of $3,000. The portion of ADSP allocable
to the Class V assets is finally determined by taking into account
this loss as follows:
ADSP = (G ! (I + II)) + L + T ÷ [(II ! B ) + (ADSP ! B )
+ (ADSP ! ! ! ! V RIIVVVII B )] VII ADSP = ($140,000 ! ($10,000 +
$10,000)) + $50,000 + .34 ÷ [($10,000 ! ! V $4,000) + (ADSP !
$30,000) + ($0 ! ! $3,000)] ! V ADSP = $160,820 + .34 ADSP VV .66
ADSP = $160,820 V ADSP = $243,666.67 V
(v) The allocation of ADSP among the Class V assets is in
proportion to V their fair market values, as follows:
Asset ADSP Gain
Land ........... $34,113.33 $29,113.33
(capital gain)
Building......... 48,733.34 38,733.34
(capital gain)
Equipment A..... 87,720.00 82,720.00
(75,000 ordinary income
(7,720 capital gain)
Equipment B..... 73,100.00 63,100.00
(10,000 ordinary income
53,100 capital gain)
Totals..... $243,666.67 $213,666.67
Example 3. More than one class.
(i) The facts are the same as in Example 2, except that P purchases
the T stock for $150,000, rather than $140,000. The amount realized
for the stock determined as if the selling shareholder(s) were
required to use old target's accounting methods and characteristics
is also $150,000.
(ii) As in Example 2, ADSP exceeds $20,000. Thus, $10,000 of ADSP
is allocated to the cash and $10,000 to the actively traded
securities.
(iii) The portion of ADSP allocable to the Class V assets as
preliminarily determined under the formula set forth in paragraph
(iii) of Example 2 is $260,363.64. The amount allocated to the Class
V assets cannot exceed their aggregate fair market value ($250,000).
Thus, preliminarily, the ADSP amount allocated to Class V assets is
$250,000.
(iv) Based on the preliminary allocation, the ADSP is determined
as follows (in the formula, the amount allocated to the Class I
assets is referred to as I, the amount allocated to the Class II
assets as II, and the amount allocated to the Class V assets as V):
ADSP = G + L + T ÷ [(II ! B ) + (V ! B ) + (ADSP ! (I + II
+ V+ B ))] ! ! ! R IIV VII ADSP = $150,000 + $50,000 + .34 ÷
[($10,000 ! $4,000) + ($250,000 ! ! $30,000) + (ADSP ! ! ($10,000 +
$10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP ! ! $15,980 .66ADSP = $184,020 ADSP =
$278,818.18
(v) Because ADSP as determined exceeds the aggregate fair market
value of the Class I, II, III, IV, V, and VI assets, the $250,000
amount preliminarily allocated to the Class V assets is appropriate.
Thus, the amount of ADSP allocated to Class V assets equals their
aggregate fair market value ($250,000), and the allocated ADSP
amount for each Class V asset is its fair market value. Further,
because there are no Class VI assets, the allocable ADSP amount for
the Class VII asset (goodwill) is $8,818.18 (the excess of ADSP over
the aggregate ADSP amounts for the Class I, II, III, IV, V and VI
assets).
Example 4. Amount allocated to T1 stock.
(i) The facts are the same as in Example 2, except that T owns all
of the T1 stock (instead of the building), and T1's only asset is
the building. The T1 stock and the building each have a fair market
value of $50,000, and the building has a basis of $10,000. A section
338 election is made for T1 (as well as T), and T1 has no
liabilities other than the tax liability for the deemed sale tax
consequences. T is the common parent of a consolidated group filing
a final consolidated return described in §1.338- 10(a)(1).
(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to
the cash and $10,000 to the actively traded securities.
(iii) Because T does not recognize any gain on the deemed sale of
the T1 stock under paragraph (h)(2) of this section, appropriate
adjustments must be made to reflect accurately the fair market value
of the T and T1 assets in determining the allocation of ADSP among
T's Class V assets (including the T1 stock). In preliminarily
calculating ADSP in this case, the T1 stock can be V disregarded
and, because T owns all of the T1 stock, the T1 asset can be treated
as a T asset. Under this assumption, ADSP is $243,666.67. See V
paragraph (iv) of Example 2.
(iv) Because the portion of the preliminary ADSP allocable to
Class V assets ($243,666.67) does not exceed their fair market value
($250,000), no amount is allocated to Class VII assets for T.
Further, this amount ($243,666.67) is allocated among T's Class V
assets in proportion to their fair market values. See paragraph (v)
of Example 2. Tentatively, $48,733.34 of this amount is allocated to
the T1 stock.
(v) The amount tentatively allocated to the T1 stock, however,
reflects the tax incurred on the deemed sale of the T1 asset equal
to $13,169.34 (.34 ÷ ($48,733.34 ! ! $10,000)). Thus, the
ADSP allocable to the Class V assets of T, and the ADSP allocable to
the T1 stock, as preliminarily calculated, each must be reduced by
$13,169.34. Consequently, these amounts, respectively, are
$230,497.33 and $35,564.00. In determining ADSP for T1, the grossed-
up amount realized on the deemed sale to new T of new T's recently
purchased T1 stock is $35,564.00.
(vi) The facts are the same as in paragraph (i) of this Example
4, except that the T1 building has a $12,500 basis and a $62,500
value, all of the outstanding T1 stock has a $62,500 value, and T
owns 80 percent of the T1 stock. In preliminarily calculating ADSP ,
the T1 stock can be disregarded but, V because T owns only 80
percent of the T1 stock, only 80 percent of T1 asset basis and value
should be taken into account in calculating T's ADSP. By taking into
account 80 percent of these amounts, the remaining calculations and
results are the same as in paragraphs (ii), (iii), (iv), and (v) of
this Example 4, except that the grossed-up amount realized on the
sale of the recently purchased T1 stock is $44,455.00
($35,564.00/0.8).
(h) Deemed sale of target affiliate stock--(1) Scope. This
paragraph (h) prescribes rules relating to the treatment of gain or
loss realized on the deemed sale of stock of a target affiliate when
a section 338 election (but not a section 338(h)(10) election) is
made for the target affiliate. For purposes of this paragraph (h),
the definition of domestic corporation in §1.338-2(c)(9) is
applied without the exclusion therein for DISCs, corporations
described in section 1248(e), and corporations to which an election
under section 936 applies.
(2) In general. Except as otherwise provided in this paragraph
(h), if a section 338 election is made for target, target recognizes
no gain or loss on the deemed sale of stock of a target affiliate
having the same acquisition date and for which a section 338
election is made if--
(i) Target directly owns stock in the target affiliate satisfying
the requirements of section 1504(a)(2);
(ii) Target and the target affiliate are members of a
consolidated group filing a final consolidated return described in
§1.338-10(a)(1); or
(iii) Target and the target affiliate file a combined return
under §1.338- 10(a)(4).
(3) Deemed sale of foreign target affiliate by a domestic target.
A domestic target recognizes gain or loss on the deemed sale of
stock of a foreign target affiliate. For the proper treatment of
such gain or loss, see, e.g., sections 1246, 1248, 1291 et seq., and
338(h)(16) and §1.338-9.
(4) Deemed sale producing effectively connected income. A foreign
target recognizes gain or loss on the deemed sale of stock of a
foreign target affiliate to the extent that such gain or loss is
effectively connected (or treated as effectively connected) with the
conduct of a trade or business in the United States.
(5) Deemed sale of insurance company target affiliate electing
under section 953(d). A domestic target recognizes gain (but not
loss) on the deemed sale of stock of a target affiliate that has in
effect an election under section 953(d) in an amount equal to the
lesser of the gain realized or the earnings and profits described in
section 953(d)(4)(B).
(6) Deemed sale of DISC target affiliate. A foreign or domestic
target recognizes gain (but not loss) on the deemed sale of stock of
a target affiliate that is a DISC or a former DISC (as defined in
section 992(a)) in an amount equal to the lesser of the gain
realized or the amount of accumulated DISC income determined with
respect to such stock under section 995(c). Such gain is included in
gross income as a dividend as provided in sections 995(c)(2) and
996(g).
(7) Anti-stuffing rule. If an asset the adjusted basis of which
exceeds its fair market value is contributed or transferred to a
target affiliate as transferred basis property (within the meaning
of section 7701(a)(43)) and a purpose of such transaction is to
reduce the gain (or increase the loss) recognized on the deemed sale
of such target affiliate's stock, the gain or loss recognized by
target on the deemed sale of stock of the target affiliate is
determined as if such asset had not been contributed or transferred.
(8) Examples. The following examples illustrate this paragraph
(h):
Example 1.
(i) P makes a qualified stock purchase of T and makes a section 338
election for T. T's sole asset, all of the T1 stock, has a basis of
$50 and a fair market value of $150. T's deemed purchase of the T1
stock results in a qualified stock purchase of T1 and a section 338
election is made for T1. T1's assets have a basis of $50 and a fair
market value of $150.
(ii) T realizes $100 of gain on the deemed sale of the T1 stock,
but the gain is not recognized because T directly owns stock in T1
satisfying the requirements of section 1504(a)(2) and a section 338
election is made for T1.
(iii) T1 recognizes gain of $100 on the deemed sale of its
assets.
Example 2. The facts are the same as in Example 1, except that P
does not make a section 338 election for T1. Because a section 338
election is not made for T1, the $100 gain realized by T on the
deemed sale of the T1 stock is recognized. Example 3.
(i) P makes a qualified stock purchase of T and makes a section 338
election for T. T owns all of the stock of T1 and T2. T's deemed
purchase of the T1 and T2 stock results in a qualified stock
purchase of T1 and T2 and section 338 elections are made for T1 and
T2. T1 and T2 each own 50 percent of the vote and value of T3 stock.
The deemed purchases by T1 and T2 of the T3 stock result in a
qualified stock purchase of T3 and a section 338 election is made
for T3. T is the common parent of a consolidated group and all of
the deemed asset sales are reported on the T group's final
consolidated return. See §1.338-10(a)(1).
(ii) Because T, T1, T2 and T3 are members of a consolidated group
filing a final consolidated return, no gain or loss is recognized by
T, T1 or T2 on their respective deemed sales of target affiliate
stock. Example 4.
(i) T's sole asset, all of the FT1 stock, has a basis of $25 and a
fair market value of $150. FT1's sole asset, all of the FT2 stock,
has a basis of $75 and a fair market value of $150. FT1 and FT2 each
have $50 of accumulated earnings and profits for purposes of section
1248(c) and (d). FT2's assets have a basis of $125 and a fair market
value of $150, and their sale would not generate subpart F income
under section 951. The sale of the FT2 stock or assets would not
generate income effectively connected with the conduct of a trade or
business within the United States. FT1 does not have an election in
effect under section 953(d) and neither FT1 nor FT2 is a passive
foreign investment company.
(ii) P makes a qualified stock purchase of T and makes a section
338 election for T. T's deemed purchase of the FT1 stock results in
a qualified stock purchase of FT1 and a section 338 election is made
for FT1. Similarly, FT1's deemed purchase of the FT2 stock results
in a qualified stock purchase of FT2 and a section 338 election is
made for FT2.
(iii) T recognizes $125 of gain on the deemed sale of the FT1
stock under paragraph (h)(3) of this section. FT1 does not recognize
$75 of gain on the deemed sale of the FT2 stock under paragraph (h)
(2) of this section. FT2 recognizes $25 of gain on the deemed sale
of its assets. The $125 gain T recognizes on the deemed sale of the
FT1 stock is included in T's income as a dividend under section
1248, because FT1 and FT2 have sufficient earnings and profits for
full recharacterization ($50 of accumulated earnings and profits in
FT1, $50 of accumulated earnings and profits in FT2, and $25 of
deemed sale earnings and profits in FT2). Section 1.338-9(b). For
purposes of sections 901 through 908, the source and foreign tax
credit limitation basket of $25 of the recharacterized gain on the
deemed sale of the FT1 stock is determined under section 338(h)(16).
§1.338-5 Adjusted grossed-up basis.
(a) Scope. This section provides rules under section 338(b) to
determine
the adjusted grossed-up basis (AGUB) for target. AGUB is the amount
for which new target is deemed to have purchased all of its assets
in the deemed purchase under section 338(a)(2). AGUB is allocated
among target's assets in accordance with §1.338-6 to determine
the price at which the assets are deemed to have been purchased.
When a subsequent increase or decrease with respect to an element of
AGUB is required under general principles of tax law, redetermined
AGUB is allocated among target's assets in accordance with
§1.338-7.
(b) Determination of AGUB--(1) General rule. AGUB is the sum of--
(i) The grossed-up basis in the purchasing corporation's recently
purchased target stock;
(ii) The purchasing corporation's basis in nonrecently purchased
target stock; and
(iii) The liabilities of new target.
(2) Time and amount of AGUB--
(i) Original determination. AGUB is initially determined at the
beginning of the day after the acquisition date of target. General
principles of tax law apply in determining the timing and amount of
the elements of AGUB.
(ii) Redetermination of AGUB. AGUB is redetermined at such time and
in such amount as an increase or decrease would be required, under
general principles of tax law, with respect to an element of AGUB.
For example, AGUB is redetermined because of an increase or decrease
in the amount paid or incurred for recently purchased stock or
nonrecently purchased stock or because liabilities not originally
taken into account in determining AGUB are subsequently taken into
account. An increase or decrease to one element of AGUB also may
cause an increase or decrease to another element of AGUB. For
example, if there is an increase in the amount paid or incurred for
recently purchased stock after the acquisition date, any increase in
the basis of nonrecently purchased stock because a gain recognition
election was made is also taken into account when AGUB is
redetermined. Increases or decreases with respect to the elements of
AGUB result in the reallocation of AGUB among target's assets under
§1.338-7.
(iii) Examples. The following examples illustrate this paragraph
(b)(2): Example 1. In Year 1, T, a manufacturer, purchases a
customized delivery truck from X with purchase money indebtedness
having a stated principal amount of $100,000 . P acquires all of
the stock of T in Year 3 for $700,000 and makes a section 338
election for T. Assume T has no liabilities other than its
purchase money indebtedness to X. In Year 4, when T is neither
insolvent nor in a title 11 case, T and X agree to reduce the
amount of the purchase money indebtedness to $80,000. Assume that
the reduction would be a purchase price reduction under section
108(e)(5). T and X's agreement to reduce the amount of the
purchase money indebtedness would, under general principles of tax
law that would apply if the deemed asset sale had actually
occurred, change the amount of liabilities of old target taken
into account in determining its basis. Accordingly, AGUB is
redetermined at the time of the reduction. See paragraph (e)(2) of
this section. Thus the purchase price reduction affects the basis
of the truck only indirectly, through the mechanism of
§§1.338-6 and 1.338-7. See §1.338-4(b)(2)(iii)
Example for the effect on ADSP.
Example 2. T, an accrual basis taxpayer, is a chemical
manufacturer. In Year 1, T is obligated to remediate environmental
contamination at the site of one of its plants. Assume that all the
events have occurred that establish the fact of the liability and
the amount of the liability can be determined with reasonable
accuracy but economic performance has not occurred with respect to
the liability within the meaning of section 461(h). P acquires all
of the stock of T in Year 1 and makes a section 338 election for T.
Assume that, if a corporation unrelated to T had actually purchased
T's assets and assumed T's obligation to remediate the
contamination, the corporation would not satisfy the economic
performance requirements until Year 5. Under section 461(h), the
assumed liability would not be treated as incurred and taken into
account in basis until that time. The incurrence of the liability in
Year 5 under the economic performance rules is an increase in the
amount of liabilities properly taken into account in basis and
results in the redetermination of AGUB. (Respecting ADSP, compare
§1.461-4(d)(5), which provides that economic performance occurs
for old T as the amount of the liability is properly taken into
account in amount realized on the deemed asset sale. Thus ADSP is
not redetermined when new T satisfies the economic performance
requirements.)
(c) Grossed-up basis of recently purchased stock. The purchasing
corporation's grossed-up basis of recently purchased target stock
(as defined in section 338(b)(6)(A)) is an amount equal to--
(1) The purchasing corporation's basis in recently purchased
target stock at the beginning of the day after the acquisition date
determined without regard to the acquisition costs taken into
account in paragraph (c)(3) of this section;
(2) Multiplied by a fraction, the numerator of which is 100 minus
the number that is the percentage of target stock (by value,
determined on the acquisition date) attributable to the purchasing
corporation's nonrecently purchased target stock, and the
denominator of which is the number equal to the percentage of target
stock (by value, determined on the acquisition date) attributable to
the purchasing corporation's recently purchased target stock;
(3) Plus the acquisition costs the purchasing corporation incurred
in connection with its purchase of the recently purchased stock that
are capitalized in the basis of such stock (e.g., brokerage
commissions and any similar costs incurred by the purchasing
corporation to acquire the stock).
(d) Basis of nonrecently purchased stock; gain recognition
election--(1) No gain recognition election. In the absence of a gain
recognition election under section 338(b)(3) and this section, the
purchasing corporation retains its basis in the nonrecently
purchased stock.
(2) Procedure for making gain recognition election. A gain
recognition election may be made for nonrecently purchased stock of
target (or a target affiliate) only if a section 338 election is
made for target (or the target affiliate). The gain recognition
election is made by attaching a gain recognition statement to a
timely filed Form 8023 for target. The gain recognition statement
must contain the information specified in the form and its
instructions. The gain recognition election is irrevocable. If a
section 338(h)(10) election is made for target, see §1.338(h)
(10)-1(d)(1) (providing that the purchasing corporation is
automatically deemed to have made a gain recognition election for
its nonrecently purchased T stock).
(3) Effect of gain recognition election--
(i) In general. If the purchasing corporation makes a gain
recognition election, then for all purposes of the Internal Revenue
Code--
(A) The purchasing corporation is treated as if it sold on the
acquisition date the nonrecently purchased target stock for the
basis amount determined under paragraph (d)(3)(ii) of this section;
and
(B) The purchasing corporation's basis on the acquisition date
in nonrecently purchased target stock immediately following the
deemed sale in paragraph (d)(3)(i)(A) of this section is the basis
amount.
(ii) Basis amount. The basis amount is equal to the amount in
paragraph (c)(1) of this section (the purchasing corporation's basis
in recently purchased target stock at the beginning of the day after
the acquisition date determined without regard to the acquisition
costs taken into account in paragraph (c)(3) of this section)
multiplied by a fraction the numerator of which is the percentage of
target stock (by value, determined on the acquisition date)
attributable to the purchasing corporation's nonrecently purchased
target stock and the denominator of which is 100 percent minus the
numerator amount. Thus, if target has a single class of outstanding
stock, the purchasing corporation's basis in each share of
nonrecently purchased target stock after the gain recognition
election is equal to the average price per share of the purchasing
corporation's recently purchased target stock.
(iii) Losses not recognized. Only gains (unreduced by losses) on
the nonrecently purchased target stock are recognized.
(iv) Stock subject to election. The gain recognition election
applies to--
(A) All nonrecently purchased target stock; and
(B) Any nonrecently purchased stock in a target affiliate having
the same acquisition date as target if such target affiliate stock
is held by the purchasing corporation on such date.
(e) Liabilities of new target--
(1) In general. The liabilities of new target are the liabilities of
target as of the beginning of the day after the acquisition date
(but see §1.338-1(d)(regarding certain transactions on the
acquisition date)). In order to be taken into account in AGUB, a
liability must be a liability of target that is properly taken into
account in basis under general principles of tax law that would
apply if new target had acquired its assets from an unrelated person
for consideration that included discharge of the liabilities of that
unrelated person. Such liabilities may include liabilities for the
tax consequences resulting from the deemed sale.
(2) Time and amount of liabilities. The time for taking into
account liabilities of old target in determining AGUB and the amount
of the liabilities taken into account is determined as if new target
had acquired its assets from an unrelated person for consideration
that included the discharge of its liabilities.
(3) Interaction with deemed sale tax consequences. In general,
see §1.338-4(e). Although ADSP and AGUB are not necessarily
linked, if an increase in the amount realized for recently purchased
stock of target is taken into account after the acquisition date,
and if the tax on the deemed sale tax consequences is a liability of
target, any increase in that liability is also taken into account in
redetermining AGUB.
(f) Adjustments by the Internal Revenue Service. In connection
with the examination of a return, the Commissioner may increase (or
decrease) AGUB under the authority of section 338(b)(2) and allocate
such amounts to target's assets under the authority of section
338(b)(5) so that AGUB and the basis of target's assets properly
reflect the cost to the purchasing corporation of its interest in
target's assets. Such items may include distributions from target to
the purchasing corporation, capital contributions from the
purchasing corporation to target during the 12-month acquisition
period, or acquisitions of target stock by the purchasing
corporation after the acquisition date from minority shareholders.
See also §1.338-1(d) (regarding certain transactions on the
acquisition date).
(g) Examples. The following examples illustrate this section. For
purposes of the examples in this paragraph (g), T has no liabilities
other than the tax liability for the deemed sale tax consequences, T
shareholders incur no costs in selling the T stock, and P incurs no
costs in acquiring the T stock. The examples are as follows: Example
1.
(i) Before July 1 of Year 1, P purchases 10 of the 100 shares of T
stock for $5,000. On July 1 of Year 2, P purchases 80 shares of T
stock for $60,000 and makes a section 338 election for T. As of July
1 of Year 2, T's only asset is raw land with an adjusted basis to T
of $50,400 and a fair market value of $100,000. T has no loss or tax
credit carryovers to Year 2. T's marginal tax rate for any ordinary
income or net capital gain resulting from the deemed asset sale is
34 percent. The 10 shares purchased before July 1 of Year 1
constitute nonrecently purchased T stock with respect to P's
qualified stock purchase of T stock on July 1 of Year 2.
(ii) The ADSP formula as applied to these facts is the same as in
§1.338- 4(g) Example 1. Accordingly, the ADSP for T is
$87,672.72. The existence of nonrecently purchased T stock is
irrelevant for purposes of the ADSP formula, because that formula
treats P's nonrecently purchased T stock in the same manner as T
stock not held by P.
(iii) The total tax liability resulting from T's deemed asset
sale, as calculated under the ADSP formula, is $12,672.72.
(iv) If P does not make a gain recognition election, the AGUB of
new T's assets is $85,172.72, determined as follows (In the
following formula below, GRP is the grossed-up basis in P's recently
purchased T stock, BNP is P's basis in nonrecently purchased T
stock, L is T's liabilities, and X is P's acquisition costs for the
recently purchased T stock):
AGUB = GRP + BNP + L + X AGUB = $60,000 ÷ [(1 ! ! .1)
/.8] + $5,000 + $12,672.72 + 0 AGUB = $85,172.72 (v) If P makes a
gain recognition election, the AGUB of new T's assets is $87,672.72,
determined as follows: AGUB = $60,000 ÷ [(1 ! .1)/.8] +
$60,000 ÷ [(1 ! .1)/.8] ÷ [.1/(1 ! .1)] + ! ! !
$12,672.72 AGUB = $87,672.72
(vi) The calculation of AGUB if P makes a gain recognition election
may be simplified as follows: AGUB = $60,000/.8 + $12,672.72 AGUB =
$87,672.72 (vii) As a result of the gain recognition election, P's
basis in its nonrecently purchased T stock is increased from $5,000
to $7,500 (i.e., $60,000 ÷ [(1 ! .1)/.8] ÷ [.1/(1 ! !
.1)]). Thus, P recognizes a gain in Year 2 with respect to ! its
nonrecently purchased T stock of $2,500 (i.e., $7,500 ! ! $5,000).
Example 2. On January 1 of Year 1, P purchases one- third of the T
stock. On March 1 of Year 1, T distributes a dividend to all of its
shareholders. On April 15 of Year 1, P purchases the remaining T
stock and makes a section 338 election for T. In appropriate
circumstances, the Commissioner may decrease the AGUB of T to take
into account the payment of the dividend and properly reflect the
fair market value of T's assets deemed purchased.
Example 3.
(i) T's sole asset is a building worth $100,000. At this time, T has
100 shares of stock outstanding. On August 1 of Year 1, P purchases
10 of the 100 shares of T stock for $8,000. On June 1 of Year 2, P
purchases 50 shares of T stock for $50,000. On June 15 of Year 2, P
contributes a tract of land to the capital of T and receives 10
additional shares of T stock as a result of the contribution. Both
the basis and fair market value of the land at that time are
$10,800. On June 30 of Year 2, P purchases the remaining 40 shares
of T stock for $40,000 and makes a section 338 election for T. The
AGUB of T is $108,800.
(ii) To prevent the shifting of basis from the contributed
property to other assets of T, the Commissioner may allocate $10,800
of the AGUB to the land, leaving $98,000 to be allocated to the
building. See paragraph (f) of this section. Otherwise, applying the
allocation rules of §1.338-6 would, on these facts, result in
an allocation to the recently contributed land of an amount less
than its value of $10,800, with the difference being allocated to
the building already held by T. §1.338-6 Allocation of ADSP and
AGUB among target assets.
(a) Scope--
(1) In general. This section prescribes rules for allocating ADSP
and AGUB among the acquisition date assets of a target for which a
section 338 election is made.
(2) Fair market value--
(i) In general. Generally, the fair market value of an asset is its
gross fair market value (i.e., fair market value determined without
regard to mortgages, liens, pledges, or other liabilities). However,
for purposes of determining the amount of old target's deemed sale
tax consequences, the fair market value of any property subject to a
nonrecourse indebtedness will be treated as being not less than the
amount of such indebtedness. (For purposes of the preceding
sentence, a liability that was incurred because of the acquisition
of the property is disregarded to the extent that such liability was
not taken into account in determining old target's basis in such
property.)
(ii) Transaction costs. Transaction costs are not taken into
account in allocating ADSP or AGUB to assets in the deemed sale
(except indirectly through their effect on the total ADSP or AGUB to
be allocated).
(iii) Internal Revenue Service authority. In connection with the
examination of a return, the Internal Revenue Service may challenge
the taxpayer's determination of the fair market value of any asset
by any appropriate method and take into account all factors,
including any lack of adverse tax interests between the parties.
(b) General rule for allocating ADSP and AGUB--(1) Reduction in
the amount of consideration for Class I assets. Both ADSP and AGUB,
in the respective allocation of each, are first reduced by the
amount of Class I assets. Class I assets are cash and general
deposit accounts (including savings and checking accounts) other
than certificates of deposit held in banks, savings and loan
associations, and other depository institutions. If the amount of
Class I assets exceeds AGUB, new target will immediately realize
ordinary income in an amount equal to such excess. The amount of
ADSP or AGUB remaining after the reduction is to be allocated to the
remaining acquisition date assets.
(2) Other assets--
(i) In general. Subject to the limitations and other rules of
paragraph (c) of this section, ADSP and AGUB (as reduced by the
amount of Class I assets) are allocated among Class II acquisition
date assets of target in proportion to the fair market values of
such Class II assets at such time, then among Class III assets so
held in such proportion, then among Class IV assets so held in such
proportion, then among Class V assets so held in such proportion,
then among Class VI assets so held in such proportion, and finally
to Class VII assets. If an asset is described below as includible in
more than one class, then it is included in such class with the
lower or lowest class number (for instance, Class III has a lower
class number than Class IV).
(ii) Class II assets. Class II assets are actively traded personal
property within the meaning of section 1092(d)(1) and
§1.1092(d)-1 (determined without regard to section 1092(d)(3)).
In addition, Class II assets include certificates of deposit and
foreign currency even if they are not actively traded personal
property. Class II assets do not include stock of target affiliates,
whether or not of a class that is actively traded, other than
actively traded stock described in section 1504(a)(4). Examples of
Class II assets include U.S. government securities and publicly
traded stock.
(iii) Class III assets. Class III assets are assets that the
taxpayer marks to market at least annually for Federal income tax
purposes and debt instruments (including accounts receivable).
However, Class III assets do not include ---
(A) Debt instruments issued by persons related at the beginning of
the day following the acquisition date to the target under section
267(b) or 707;
(B) Contingent debt instruments subject to §1.1275-4,
§1.483-4, or section 988, unless the instrument is subject to
the non-contingent bond method of §1.1275-4(b) or is described
in §1.988-2(b)(2)(i)(B)(2); and
(C) Debt instruments convertible into the stock of the issuer or
other property.
(iv) Class IV assets. Class IV assets are stock in trade of the
taxpayer or other property of a kind that would properly be included
in the inventory of taxpayer if on hand at the close of the taxable
year, or property held by the taxpayer primarily for sale to
customers in the ordinary course of its trade or business.
(v) Class V assets. Class V assets are all assets other than Class
I, II, III, IV, VI, and VII assets.
(vi) Class VI assets. Class VI assets are all section 197
intangibles, as defined in section 197, except goodwill and going
concern value.
(vii) Class VII assets. Class VII assets are goodwill and going
concern value (whether or not the goodwill or going concern value
qualifies as a section 197 intangible).
(3) Other items designated by the Internal Revenue Service. Similar
items may be added to any class described in this paragraph (b) by
designation in the Internal Revenue Bulletin by the Internal Revenue
Service (see §601.601(d)(2) of this chapter).
(c) Certain limitations and other rules for allocation to an
asset--(1) Allocation not to exceed fair market value. The amount of
ADSP or AGUB allocated to an asset (other than Class VII assets)
cannot exceed the fair market value of that asset at the beginning
of the day after the acquisition date.
(2) Allocation subject to other rules. The amount of ADSP or AGUB
allocated to an asset is subject to other provisions of the Internal
Revenue Code or general principles of tax law in the same manner as
if such asset were transferred to or acquired from an unrelated
person in a sale or exchange. For example, if the deemed asset sale
is a transaction described in section 1056(a) (relating to basis
limitation for player contracts transferred in connection with the
sale of a franchise), the amount of AGUB allocated to a contract for
the services of an athlete cannot exceed the limitation imposed by
that section. As another example, section 197(f)(5) applies in
determining the amount of AGUB allocated to an amortizable section
197 intangible resulting from an assumption- reinsurance
transaction.
(3) Special rule for allocating AGUB when purchasing corporation
has nonrecently purchased stock--
(i) Scope. This paragraph (c)(3) applies if at the beginning of the
day after the acquisition date--
(A) The purchasing corporation holds nonrecently purchased stock
for which a gain recognition election under section 338(b)(3) and
§1.338-5(d) is not made; and
(B) The hypothetical purchase price determined under paragraph
(c)(3)(ii) of this section exceeds the AGUB determined under
§1.338-5(b).
(ii) Determination of hypothetical purchase price. Hypothetical
purchase price is the AGUB that would result if a gain recognition
election were made. (iii) Allocation of AGUB. Subject to the
limitations in paragraphs (c)(1)
and (2) of this section, the portion of AGUB (after reduction by the
amount of Class I assets) to be allocated to each Class II, III, IV,
V, VI, and VII asset of target held at the beginning of the day
after the acquisition date is determined by multiplying--
(A) The amount that would be allocated to such asset under the
general rules of this section were AGUB equal to the hypothetical
purchase price; by
(B) A fraction, the numerator of which is actual AGUB (after
reduction by the amount of Class I assets) and the denominator of
which is the hypothetical purchase price (after reduction by the
amount of Class I assets).
(4) Liabilities taken into account in determining amount realized
on subsequent disposition. In determining the amount realized on a
subsequent sale or other disposition of property deemed purchased by
new target, §1.1001- 2(a)(3) shall not apply to any liability
that was taken into account in AGUB.
(d) Examples. The following examples illustrate
§§1.338-4, 1.338-5, and this section: Example 1.
(i) T owns 90 percent of the outstanding T1 stock. P purchases 100
percent of the outstanding T stock for $2,000. There are no
acquisition costs. P makes a section 338 election for T and, as a
result, T1 is considered acquired in a qualified stock purchase. A
section 338 election is made for T1. The grossed-up basis of the T
stock is $2,000 (i.e., $2,000 ÷ 1/1).
(ii) The liabilities of T as of the beginning of the day after the
acquisition date (including the tax liability for the deemed sale
tax consequences) that would, under general principles of tax law,
properly be taken into account at that time, are as follows:
Liabilities (nonrecourse mortgage plus unsecured liabilities) . $ 700
Taxes Payable .................................... 300
____
Total....................................... $ 1,000
(iii) The AGUB of T is determined as follows:
-----------------------------------------------
Grossed-up basis .................................. $2,000
Total liabilities ..................................... 1,000
____
AGUB...................................... $ 3,000
(iv) Assume that ADSP is also $3,000. (v) Assume that, at the
beginning of the day after the acquisition date, T's cash and the
fair market values of T's Class II, III, IV, and V assets are as
follows:
Asset Asset Fair Class market
value
I Cash.................................... $200*
II Portfolio of actively traded securities ........... 300
III Accounts receivable ........................ 600
IV Inventory................................. 300
V Building.................................. 800
V Land .................................... 200
V Investment in T1........................... 450
_____
Total............................... $ 2,850
*Amount.
(vi) Under paragraph (b)(1) of this section, the amount of ADSP
and AGUB allocable to T's Class II, III, IV, and V assets is reduced
by the amount of cash to $2,800, i.e., $3,000 ! ! $200. $300 of
ADSP and of AGUB is then allocated to actively traded securities.
$600 of ADSP and of AGUB is then allocated to accounts receivable.
$300 of ADSP and of AGUB is then allocated to the inventory. Since
the remaining amount of ADSP and of AGUB is $1,600 (i.e., $3,000 ! !
($200 + $300 + $600 + $300)), an amount which exceeds the sum of the
fair market values of T's Class V assets, the amount of ADSP and of
AGUB allocated to each Class V asset is its fair market value:
Building.......................................... 800
Land ............................................ 200
Investment in T1................................... 450
_____
Total....................................... $ 1,450
(vii) T has no Class VI assets. The amount of ADSP and of AGUB
allocated to T's Class VII assets (goodwill and going concern value)
is $150, i.e., $1,600 ! ! $1,450.
(viii) The grossed-up basis of the T1 stock is $500, i.e., $450
÷ 1/.9.
(ix) The liabilities of T1 as of the beginning of the day after
the acquisition date (including the tax liability for the deemed
sale tax consequences) that would, under general principles of tax
law, properly be taken into account at that time, are as follows:
General Liabilities .................................. $100
Taxes Payable .................................... 20
____
Total....................................... $ 120
(x) The AGUB of T1 is determined as follows:
Grossed-up basis of T1 Stock ........................ $500
Liabilities ........................................ 120
___
AGUB...................................... $620
(xi) Assume that ADSP is also $620.
(xii) Assume that at the beginning of the day after the acquisition
date, T1's cash and the fair market values of its Class IV and VI
assets are as follows:
Asset Asset Fair Class Market
Value
I Cash.................................... $50*
IV Inventory................................. 200
VI Patent ................................... 350
____
Total .................................. $600
* Amount.
(xiii) The amount of ADSP and of AGUB allocable to T1's Class IV
and VI assets is first reduced by the $50 of cash.
(xiv) Because the remaining amount of ADSP and of AGUB ($570) is
an amount which exceeds the fair market value of T1's only Class IV
asset, the inventory, the amount allocated to the inventory is its
fair market value ($200). After that, the remaining amount of ADSP
and of AGUB ($370) exceeds the fair market value of T1's only Class
VI asset, the patent. Thus, the amount of ADSP and of AGUB allocated
to the patent is its fair market value ($350).
(xv) The amount of ADSP and of AGUB allocated to T1's Class VII
assets (goodwill and going concern value) is $20, i.e., $570 ! !
$550. Example 2.
(i) Assume that the facts are the same as in Example 1 except that P
has, for five years, owned 20 percent of T's stock, which has a
basis in P's hands at the beginning of the day after the acquisition
date of $100, and P purchases the remaining 80 percent of T's stock
for $1,600. P does not make a gain recognition election under
section 338(b)(3).
(ii) Under §1.338-5(c), the grossed-up basis of recently
purchased T stock is $1,600, i.e., $1,600 ÷ (1 ! ! .2)/.8.
(iii) The AGUB of T is determined as follows:
Grossed-up basis of recently purchased stock as determined
under §1.338-5(c) ($1,600 ÷ (1 ! ! .2)/.8).. $ 1,600
Basis of nonrecently purchased stock .................. 100
Liabilities ........................................ 1,000
_____
AGUB...................................... $2,700
(iv) Since P holds nonrecently purchased stock, the hypothetical
purchase price of the T stock must be computed and is determined as
follows:
Grossed-up basis of recently purchased stock as determined
under §1.338-5(c) ($1,600 ÷ (1 ! ! .2)/.8). $1,600
Basis of nonrecently purchased stock as if the gain
recognition election under §1.338-5(d)(2) had been made
($1,600 ÷ .2/(1 ! ! .2)) ........................... . 400
Liabilities ........................................ 1,000
_____
Total ................................. $3,000
(v) Since the hypothetical purchase price ($3,000) exceeds the
AGUB ($2,700) and no gain recognition election is made under section
338(b)(3), AGUB is allocated under paragraph (c)(3) of this section.
(vi) First, an AGUB amount equal to the hypothetical purchase price
($3,000) is allocated among the assets under the general rules of
this section. The allocation is set forth in the column below
entitled Original Allocation. Next, the allocation to each asset in
Class II through Class VII is multiplied by a fraction having a
numerator equal to the actual AGUB reduced by the amount of Class I
assets ($2,700 ! ! $200 = $2,500) and a denominator equal to the
hypothetical purchase price reduced by the amount of Class I assets
($3,000 ! $200 = $2,800), or 2,500/2,800. This produces
the Final Allocation:
Class Asset Original Final
Allocation Allocation
I Cash....................... $200 $200
II Portfolio of actively traded 300 268*
securities ...................
III Accounts receivable ........... 600 536
IV Inventory.................... 300 268
V Building..................... 800 714
V Land ....................... 200 178
V Investment in T1.............. 450 402
VII Goodwill and going concern value 150 134
_____ _____
Total.................. $ 3,000 $ 2,700
* All numbers rounded for convenience. §1.338-7 Allocation
of redetermined ADSP and AGUB among target assets.
(a) Scope. ADSP and AGUB are redetermined at such time and in
such amount as an increase or decrease would be required under
general principles of tax law for the elements of ADSP or AGUB. This
section provides rules for allocating redetermined ADSP or AGUB.
(b) Allocation of redetermined ADSP and AGUB. When ADSP or AGUB is
redetermined, a new allocation of ADSP or AGUB is made by allocating
the redetermined ADSP or AGUB amount under the rules of
§1.338-6. If the allocation of the redetermined ADSP or AGUB
amount under §1.338-6 to a given asset is different from the
original allocation to it, the difference is added to or subtracted
from the original allocation to the asset, as appropriate. (See
paragraph (d) of this section for new target's treatment of the
amount so allocated.) Amounts allocable to an acquisition date asset
(or with respect to a disposed-of acquisition date asset) are
subject to all the asset allocation rules (for example, the fair
market value limitation in §1.338-6(c)(1)) as if the
redetermined ADSP or AGUB were the ADSP or AGUB on the acquisition
date.
(c) Special rules for ADSP--(1) Increases or decreases in deemed
sale tax consequences taxable notwithstanding old target ceases to
exist. To the extent general principles of tax law would require a
seller in an actual asset sale to account for events relating to the
sale that occur after the sale date, target must make such an
accounting. Target is not precluded from realizing additional deemed
sale tax consequences because the target is treated as a new
corporation after the acquisition date.
(2) Procedure for transactions in which section 338(h)(10) is not
elected-- (i) Deemed sale tax consequences included in new target's
return. If an election under section 338(h)(10) is not made, any
additional deemed sale tax consequences of old target resulting from
an increase or decrease in the ADSP are included in new target's
income tax return for new target's taxable year in which the
increase or decrease is taken into account. For example, if after
the acquisition date there is an increase in the allocable ADSP of
section 1245 property for which the recomputed basis (but not the
adjusted basis) exceeds the portion of the ADSP allocable to that
particular asset on the acquisition date, the additional gain is
treated as ordinary income to the extent it does not exceed such
excess amount. See paragraph (c)(2)(ii) of this section for the
special treatment of old target's carryovers and carrybacks.
Although included in new target's income tax return, the deemed sale
tax consequences are separately accounted for as an item of old
target and may not be offset by income, gain, deduction, loss,
credit, or other amount of new target. The amount of tax on income
of old target resulting from an increase or decrease in the ADSP is
determined as if such deemed sale tax consequences had been
recognized in old target's taxable year ending at the close of the
acquisition date. However, because the income resulting from the
increase or decrease in ADSP is reportable in new target's taxable
year of the increase or decrease, not in old target's taxable year
ending at the close of the acquisition date, there is not a
resulting underpayment of tax in that past taxable year of old
target for purposes of calculation of interest due.
(ii) Carryovers and carrybacks--(A) Loss carryovers to new target
taxable years. A net operating loss or net capital loss of old
target may be carried forward to a taxable year of new target, under
the principles of section 172 or 1212, as applicable, but is allowed
as a deduction only to the extent of any recognized income of old
target for such taxable year, as described in paragraph (c)(2)(i) of
this section. For this purpose, however, taxable years of new target
are not taken into account in applying the limitations in section
172(b)(1) or 1212(a)(1)(B) (or other similar limitations). In
applying sections 172(b) and 1212(a)(1), only income, gain, loss,
deduction, credit, and other amounts of old target are taken into
account. Thus, if old target has an unexpired net operating loss at
the close of its taxable year in which the deemed asset sale
occurred that could be carried forward to a subsequent taxable year,
such loss may be carried forward until it is absorbed by old
target's income.
(B) Loss carrybacks to taxable years of old target. An ordinary
loss or capital loss accounted for as a separate item of old target
under paragraph (c)(2)(i) of this section may be carried back to a
taxable year of old target under the principles of section 172 or
1212, as applicable. For this purpose, taxable years of new target
are not taken into account in applying the limitations in section
172(b) or 1212(a) (or other similar limitations).
(C) Credit carryovers and carrybacks. The principles described in
paragraphs (c)(2)(ii)(A) and (B) of this section apply to carryovers
and carrybacks of amounts for purposes of determining the amount of
a credit allowable under part IV, subchapter A, chapter 1 of the
Internal Revenue Code. Thus, for example, credit carryovers of old
target may offset only income tax attributable to items described in
paragraph (c)(2)(i) of this section.
(3) Procedure for transactions in which section 338(h)(10) is
elected. If an election under section 338(h)(10) is made, any
changes in the deemed sale tax consequences caused by an increase or
decrease in the ADSP are accounted for in determining the taxable
income (or other amount) of the member of the selling consolidated
group, the selling affiliate, or the S corporation shareholders to
which such income, loss, or other amount is attributable for the
taxable year in which such increase or decrease is taken into
account.
(d) Special rules for AGUB--(1) Effect of disposition or
depreciation of acquisition date assets. If an acquisition date
asset has been disposed of, depreciated, amortized, or depleted by
new target before an amount is added to the original allocation to
the asset, the increased amount otherwise allocable to such asset is
taken into account under general principles of tax law that apply
when part of the cost of an asset not previously taken into account
in basis is paid or incurred after the asset has been disposed of,
depreciated, amortized, or depleted. A similar rule applies when an
amount is subtracted from the original allocation to the asset. For
purposes of the preceding sentence, an asset is considered to have
been disposed of to the extent that its allocable portion of the
decrease in AGUB would reduce its basis below zero.
(2) Section 38 property. Section 1.47-2(c) applies to a reduction
in basis of section 38 property under this section.
(e) Examples. The following examples illustrate this section. Any
amount described in the following examples is exclusive of interest.
For rules characterizing deferred contingent payments as principal
or interest, see §§1.483-4, 1.1274-2(g), and 1.1275-4(c).
The examples are as follows:
Example 1.
(i)(A) T's assets other than goodwill and going concern value, and
their fair market values at the beginning of the day after the
acquisition date, are as follows:
Asset Asset Fair
Class Market
Value
V Building.................................. $100
V Stock of X (not a target) ..................... 200
___
Total......................... $ 300
(B) T has no liabilities other than a contingent liability that
would not be taken into account under general principles of tax law
in an asset sale between unrelated parties when the buyer assumed
the liability or took property subject to it. (ii)(A) On September
1, 2000, P purchases all of the outstanding stock of T for $270 and
makes a section 338 election for T. The grossed-up basis of the T
stock and T's AGUB are both $270. The AGUB is ratably allocated
among T's Class V assets in proportion to their fair market values
as follows:
Asset Basis
Building ($270 ÷ 100/300) .................... $90
Stock ($270 ÷ 200/300) ...................... 180
____
Total....................................... $270
(B) No amount is allocated to the Class VII assets. New T is a
calendar year taxpayer. Assume that the X stock is a capital asset
in the hands of new T.
(iii) On January 1, 2001, new T sells the X stock and uses the
proceeds to purchase inventory.
(iv) Pursuant to events on June 30, 2002, the contingent liability
of old T is at that time properly taken into account under general
principles of tax law. The amount of the liability is $60.
(v) T's AGUB increases by $60 from $270 to $330. This $60 increase
in AGUB is first allocated among T's acquisition date assets in
accordance with the provisions of §1.338-6. Because the
redetermined AGUB for T ($330) exceeds the sum of the fair market
values at the beginning of the day after the acquisition date of the
Class V acquisition date assets ($300), AGUB allocated to those
assets is limited to those fair market values under §1.338-6(c)
(1). As there are no Class VI assets, the remaining AGUB of $30 is
allocated to goodwill and going concern value (Class VII assets).
The amount of increase in AGUB allocated to each acquisition date
asset is determined as follows:
Asset Original Redetermined Increase
AGUB AGUB
Building.......... $90 $100 $10
X Stock .......... 180 200 20
Goodwill and going 30 30
concern value..... ____ ____ ____
Total....... $270 $330 $60
(vi) Since the X stock was disposed of before the contingent
liability was properly taken into account for tax purposes, no
amount of the increase in AGUB attributable to such stock may be
allocated to any T asset. Rather, such amount ($20) is allowed as a
capital loss to T for the taxable year 2002 under the principles of
Arrowsmith v. Commissioner, 344 U.S. 6 (1952). In addition, the $10
increase in AGUB allocated to the building and the $30 increase in
AGUB allocated to the goodwill and going concern value are treated
as basis redeterminations in 2002. See paragraph (d)(1) of this
section. Example 2.
(i) On January 1, 2002, P purchases all of the outstanding stock of
T and makes a section 338 election for T. Assume that ADSP and AGUB
of T are both $500 and are allocated among T's acquisition date
assets as follows:
Asset Asset Basis
Class
V Machinery................................ $ 150
V Land .................................... 250
VII Goodwill and going concern value ........ 100
___
Total................... $ 500
(ii) On September 30, 2004, P filed a claim against the selling
shareholders of T in a court of appropriate jurisdiction alleging
fraud in the sale of the T stock.
(iii) On January 1, 2007, the former shareholders refund $140 of
the purchase price to P in a settlement of the lawsuit. Assume that,
under general principles of tax law, both the seller and the buyer
properly take into account such refund when paid. Assume also that
the refund has no effect on the tax liability for the deemed sale
tax consequences. This refund results in a decrease of T's ADSP and
AGUB of $140, from $500 to $360.
(iv) The redetermined ADSP and AGUB of $360 is allocated among T's
acquisition date assets. Because ADSP and AGUB do not exceed the
fair market value of the Class V assets, the ADSP and AGUB amounts
are allocated to the Class V assets in proportion to their fair
market values at the beginning of the day after the acquisition
date. Thus, $135 ($150 ÷ ($360/($150 + $250))) is allocated
to the machinery and $225 ($250 ÷ ($360/($150 + $250))) is
allocated to the land. Accordingly, the basis of the machinery is
reduced by $15 ($150 original allocation ! ! $135 redetermined
allocation) and the basis of the land is reduced by $25 ($250
original allocation ! ! $225 redetermined allocation). No amount
is allocated to the Class VII assets. Accordingly, the basis of the
goodwill and going concern value is reduced by $100 ($100 original
allocation ! $0 redetermined allocation).
(v) Assume that, as a result of deductions under section 168, the
adjusted basis of the machinery immediately before the decrease in
AGUB is zero. The machinery is treated as if it were disposed of
before the decrease is taken into account. In 2007, T recognizes
income of $15, the character of which is determined under the
principles of Arrowsmith v. Commissioner and the tax benefit rule.
No adjustment to the basis of T's assets is made for any tax paid on
this amount. Assume also that, as a result of amortization
deductions, the adjusted basis of the goodwill and going concern
value immediately before the decrease in AGUB is $40. A similar
adjustment to income is made in 2007 with respect to the $60 of
previously amortized goodwill and going concern value. (vi) In
summary, the basis of T's acquisition date assets, as of January 1,
2007, is as follows:
Asset Basis
Machinery........................................ $ 0
Land ............................................ 225
Goodwill and going concern value .................. 0
Example 3.
(i) Assume that the facts are the same as §1.338-6(d) Example 2
except that the recently purchased stock is acquired for $1,600 plus
additional payments that are contingent upon T's future earnings.
Assume that, under general principles of tax law, such later
payments are properly taken into account when paid. Thus, T's AGUB,
determined as of the beginning of the day after the acquisition date
(after reduction by T's cash of $200), is $2,500 and is allocated
among T's acquisition date assets under §1.338-6(c)(3)(iii) as
follows:
Class Asset Final
Allocation
I Cash.................................. $ 200
II Portfolio of actively traded securities 268*
III Accounts receivable .................. 536
IV Inventory.............................. 268
V Building................................ 714
V Land ................................... 178
V Investment in T1........................ 402
VII Goodwill and going concern value ..... 134
_____
Total.................. 2,700
* All numbers rounded for convenience. (ii) At a later point in
time, P pays an additional $200 for its recently purchased T
stock. Assume that the additional consideration paid would not
increase T's tax liability for the deemed sale tax consequences.
(iii) T's AGUB increases by $200, from $2,700 to $2,900. This $200
increase in AGUB is accounted for in accordance with the
provisions of §1.338- 6(c)(3)(iii). (iv) The hypothetical
purchase price of the T stock is redetermined as follows:
Grossed-up basis of recently purchased stock as determined
under §1.338-5(c) ($1,800 ÷ (1.2)/.8)...$1,800
Basis of nonrecently purchased stock as if the gain
recognition election under §1.338-5(d)(2)
had been made ($1,800 ÷ .2/(1 ! ! .2)) ...... 450
Liabilities ........................................ 1,000
_____
Total.......................................$3,250
(v) Since the redetermined hypothetical purchase price ($3,250)
exceeds the redetermined AGUB ($2,900) and no gain recognition
election was made under section 338(b)(3), the rules of
§1.338-6(c)(3)(iii) are reapplied using the redetermined
hypothetical purchase price and the redetermined AGUB.
(vi) First, an AGUB amount equal to the redetermined hypothetical
purchase price ($3,250) is allocated among the assets under the
general rules of §1.338-6. The allocation is set forth in the
column below entitled Hypothetical Allocation. Next, the allocation
to each asset in Class II through Class VII is multiplied by a
fraction with a numerator equal to the actual redetermined AGUB
reduced by the amount of Class I assets ($2,900 ! ! $200 =
$2,700) and a denominator equal to the redetermined hypothetical
purchase price reduced by the amount of Class I assets ($3,250 !
! $200 = $3,050), or 2,700/3,050. This produces the Final
Allocation:
Class Asset Hypothetical Final
Allocation Allocation
I Cash................. $200 $200
II Portfolio of actively traded 300 266*
securities .............
III Accounts receivable ..... 600 531
IV Inventory.............. 300 266
V Building............... 800 708
V Land ................. 200 177
V Investment in T1........ 450 398
VII Goodwill and going concern 400 354
value................. _____ _____
Total............ $3,250 $2900
* All numbers rounded for convenience.
(vii) As illustrated by this example, reapplying §1.338-6(c)
(3) results in a basis increase for some assets and a basis decrease
for other assets. The amount of redetermined AGUB allocated to each
acquisition date asset is determined as follows:
Asset Original Redetermined Increase
(c)(3) (c)(3) (decrease)
Allocation Allocation
Portfolio of actively $268 $266 $(2)
traded securities . . .
Accounts receivable 536 531 (5)
Inventory . . . . . . . . . 268 266 (2)
Building.......... 714 708 (6)
Land ............ 178 177 (1)
Investment in T1 . . . 402 398 (4)
Goodwill and going 134 354 220
concern value..... ___ ___ ___
Total....... $2,500 $2,700 $200
Example 4.
(i) On January 1, 2001, P purchases all of the outstanding T stock
and makes a section 338 election for T. P pays $700 of cash and
promises also to pay a maximum $300 of contingent consideration at
various times in the future. Assume that, under general principles
of tax law, such later payments are properly taken into account by P
when paid. Assume also, however, that the current fair market value
of the contingent payments is reasonably ascertainable. The fair
market value of T's assets (other than goodwill and going concern
value) as of the beginning of the following day is as follows:
Asset Assets Fair
Class market
value
V Equipment ............................... $ 200
V Non-actively traded securities ............ 100
V Building.................................. 500
___
Total.................... . 800
(ii) T has no liabilities. The AGUB is $700. In calculating ADSP,
assume that, under §1.1001-1, the current amount realized
attributable to the contingent consideration is $200. ADSP is
therefore $900 ($700 cash plus $200).
(iii) (A) The AGUB of $700 is ratably allocated among T's Class V
acquisition date assets in proportion to their fair market values as
follows:
Asset Basis
Equipment ($700 ÷ 200/800) ...................... $175.00
Non-actively traded securities ($700 ÷ 100/800) ... 87.50
Building ($700 ÷ 500/800) ........................ 437.50
______
Total.................................... $700.00
(B) No amount is allocated to goodwill or going concern value.
(iv) (A) The ADSP of $900 is ratably allocated among T's Class V
acquisition date assets in proportion to their fair market values
as follows:
Asset Basis
Equipment .................................... $200
Non-actively traded securities ................. 100
Building....................................... 500
_____
Total....................................$800
(B) The remaining ADSP, $100, is allocated to goodwill and going
concern value (Class VII).
(v) P and T file a consolidated return for 2001 and each following
year with P as the common parent of the affiliated group.
(vi) In 2004, a contingent amount of $120 is paid by P. For old T,
this payment has no effect on ADSP, because the payment is accounted
for as a separate transaction. We have assumed that, under general
principles of tax law, the payment is properly taken into account by
P at the time made. Therefore, in 2004, there is an increase in new
T's AGUB of $120. The amount of the increase allocated to each
acquisition date asset is determined as follows: -
Asset Original Redetermined Increase
AGUB AGUB
Equipment ....... $175.00 $200.00 $25.00
Land ............ 87.50 100.00 12.50
Building.......... 437.50 500.00 62.50
Goodwill and going 0.00 20.00 20.00
concern value..... ______ ______ ______
Total....... $ 700.00 $ 820.00 $ 120.00
§§1.338-0T through 1.338-7T [Removed] Par. 4. Sections
1.338-0T through 1.338-7T are removed. Par. 5. Section 1.338-10
is added to read as follows: §1.338-10 Filing of returns.
(a) Returns including tax liability from deemed asset sale--
(1) In general. Except as provided in paragraphs (a)(2) and (3) of
this section, any deemed sale tax consequences are reported on the
final return of old target filed for old target's taxable year that
ends at the close of the acquisition date. Paragraphs (a)(2), (3)
and (4) of this section do not apply to elections under section
338(h)(10). If old target is the common parent of an affiliated
group, the final return may be a consolidated return (any such
consolidated return must also include any deemed sale tax
consequences of any members of the consolidated group that are
acquired by the purchasing corporation on the same acquisition date
as old target). (2) Old target's final taxable year otherwise
included in consolidated return of selling group--
(i) General rule. If the selling group files a consolidated return
for the period that includes the acquisition date, old target is
disaffiliated from that group immediately before the deemed asset
sale and must file a deemed sale return separate from the group,
which includes only the deemed sale tax consequences and the
carryover items specified in paragraph (a)(2)(iii) of this section.
The deemed asset sale occurs at the close of the acquisition date
and is the last transaction of old target and the only transaction
reported on the separate return. Except as provided in
§1.338-1(d) (regarding certain transactions on the acquisition
date), any transactions of old target occurring on the acquisition
date other than the deemed asset sale are included in the selling
group's consolidated return. A deemed sale return includes a
combined deemed sale return as defined in paragraph (a)(4) of this
section.
(ii) Separate taxable year. The deemed asset sale included in the
deemed sale return under this paragraph (a)(2) occurs in a separate
taxable year, except that old target's taxable year of the sale and
the consolidated year of the selling group that includes the
acquisition date are treated as the same year for purposes of
determining the number of years in a carryover or carryback period.
(iii) Carryover and carryback of tax attributes. Target's
attributes may be carried over to, and carried back from, the deemed
sale return under the rules applicable to a corporation that ceases
to be a member of a consolidated group.
(iv) Old target is a component member of purchasing corporation's
controlled group. For purposes of its deemed sale return, target is
a component member of the controlled group of corporations including
the purchasing corporation unless target is treated as an excluded
member under section 1563(b)(2).
(3) Old target is an S corporation. If target is an S corporation
for the period that ends on the day before the acquisition date and
a section 338 election (but not a section 338(h)(10) election) is
filed for target, old target files a return as a C corporation
reflecting its activities on the acquisition date, including
target's deemed sale. See section 1362(d)(2). For purposes of this
return, target is a component member of the controlled group of
corporations including the purchasing corporation unless target is
treated as an excluded member under section 1563(b)(2).
(4) Combined deemed sale return--
(i) General rule. Under section 338(h)(15), a combined deemed sale
return (combined return) may be filed for all targets from a single
selling consolidated group (as defined in §1.338(h)(10)- 1(b)
(3)) that are acquired by the purchasing corporation on the same
acquisition date and that otherwise would be required to file
separate deemed sale returns. The combined return must include all
such targets. For example, T and T1 may be included in a combined
return if--
(A) T and T1 are directly owned subsidiaries of S;
(B) S is the common parent of a consolidated group; and
(C) P makes qualified stock purchases of T and T1 on the same
acquisition date.
(ii) Gain and loss offsets. Gains and losses recognized on the
deemed asset sales by targets included in a combined return are
treated as the gains and losses of a single target. In addition,
loss carryovers of a target that were not subject to the separate
return limitation year restrictions (SRLY restrictions) of the
consolidated return regulations while that target was a member of
the selling consolidated group may be applied without limitation to
the gains of other targets included in the combined return. If,
however, a target has loss carryovers that were subject to the SRLY
restrictions while that target was a member of the selling
consolidated group, the use of those losses in the combined return
continues to be subject to those restrictions, applied in the same
manner as if the combined return were a consolidated return. A
similar rule applies, when appropriate, to other tax attributes.
(iii) Procedure for filing a combined return. A combined return is
made by filing a single corporation income tax return in lieu of
separate deemed sale returns for all targets required to be included
in the combined return. The combined return reflects the deemed
asset sales of all targets required to be included in the combined
return. If the targets included in the combined return constitute a
single affiliated group within the meaning of section 1504(a), the
income tax return is signed by an officer of the common parent of
that group. Otherwise, the return must be signed by an officer of
each target included in the combined return. Rules similar to the
rules in §1.1502-75(j) apply for purposes of preparing the
combined return. The combined return must include an attachment
prominently identified as an "ELECTION TO FILE A COMBINED RETURN
UNDER SECTION 338(h)(15)." The attachment must--
(A) Contain the name, address, and employer identification number
of each target required to be included in the combined return;
(B) Contain the following declaration (or a substantially similar
declaration): EACH TARGET IDENTIFIED IN THIS ELECTION TO FILE A
COMBINED RETURN CONSENTS TO THE FILING OF A COMBINED RETURN;
(C) For each target, be signed by a person who states under
penalties of perjury that he or she is authorized to act on behalf
of such target.
(iv) Consequences of filing a combined return. Each target
included in a combined return is severally liable for any tax
associated with the combined return. See §1.338-1(b)(3).
(5) Deemed sale excluded from purchasing corporation's
consolidated return. Old target may not be considered a member of
any affiliated group that includes the purchasing corporation with
respect to its deemed asset sale.
(6) Due date for old target's final return--
(i) General rule. Old target's final return is generally due on the
15th day of the third calendar month following the month in which
the acquisition date occurs. See section 6072 (time for filing
income tax returns).
(ii) Application of §1.1502-76(c)--(A) In general. Section
1.1502-76(c) applies to old target's final return if old target was
a member of a selling group that did not file consolidated returns
for the taxable year of the common parent that precedes the year
that includes old target's acquisition date. If the selling group
has not filed a consolidated return that includes old target's
taxable period that ends on the acquisition date, target may, on or
before the final return due date (including extensions), either--
(1) File a deemed sale return on the assumption that the selling
group will file the consolidated return; or
(2) File a return for so much of old target's taxable period as
ends at the close of the acquisition date on the assumption that the
consolidated return will not be filed.
(B) Deemed extension. For purposes of applying
§1.1502-76(c)(2), an extension of time to file old target's
final return is considered to be in effect until the last date for
making the election under section 338.
(C) Erroneous filing of deemed sale return. If, under this
paragraph (a)(6)(ii), target files a deemed sale return but the
selling group does not file a consolidated return, target must file
a substituted return for old target not later than the due date
(including extensions) for the return of the common parent with
which old target would have been included in the consolidated
return. The substituted return is for so much of old target's
taxable year as ends at the close of the acquisition date. Under
§1.1502-76(c)(2), the deemed sale return is not considered a
return for purposes of section 6011 (relating to the general
requirement of filing a return) if a substituted return must be
filed.
(D) Erroneous filing of return for regular tax year. If, under
this paragraph (a)(6)(ii), target files a return for so much of old
target's regular taxable year as ends at the close of the
acquisition date but the selling group files a consolidated return,
target must file an amended return for old target not later than the
due date (including extensions) for the selling group's consolidated
return. (The amended return is a deemed sale return.)
(E) Last date for payment of tax. If either a substituted or
amended final return of old target is filed under this paragraph (a)
(6)(ii), the last date prescribed for payment of tax is the final
return due date (as defined in paragraph (a)(6)(i) of this section).
(7) Examples. The following examples illustrate this paragraph
(a): Example 1.
(i) S is the common parent of a consolidated group that includes T.
The S group files calendar year consolidated returns. At the close
of June 30 of Year 1, P makes a qualified stock purchase of T from
S. P makes a section 338 election for T, and T's deemed asset sale
occurs as of the close of T's acquisition date (June 30).
(ii) T is considered disaffiliated for purposes of reporting the
deemed sale tax consequences. Accordingly, T is included in the S
group's consolidated return through T's acquisition date except that
the tax liability for the deemed sale tax consequences is reported
in a separate deemed sale return of T. Provided that T is not
treated as an excluded member under section 1563(b)(2), T is a
component member of P's controlled group for the taxable year of the
deemed asset sale, and the taxable income bracket amounts available
in calculating tax on the deemed sale return must be limited
accordingly.
(iii) If P purchased the stock of T at 10 a.m. on June 30 of Year
1, the results would be the same. See paragraph (a)(2)(i) of this
section.
Example 2. The facts are the same as in Example 1, except that
the S group does not file consolidated returns. T must file a
separate return for its taxable year ending on June 30 of Year 1,
which return includes the deemed asset sale.
(b) Waiver--(1) Certain additions to tax. An addition to tax or
additional amount (addition) under subchapter A of chapter 68 of the
Internal Revenue Code arising on or before the last day for making
the election under section 338 because of circumstances that would
not exist but for an election under section 338 is waived if--
(i) Under the particular statute the addition is excusable upon a
showing of reasonable cause; and
(ii) Corrective action is taken on or before the last day.
(2) Notification. The Internal Revenue Service should be notified
at the time of correction (e.g., by attaching a statement to a
return that constitutes corrective action) that the waiver rule of
this paragraph (b) is being asserted.
(3) Elections or other actions required to be specified on a
timely filed return--
(i) In general. If paragraph (b)(1) of this section applies or would
apply if there were an underpayment, any election or other action
that must be specified on a timely filed return for the taxable
period covered by the late filed return described in paragraph (b)
(1) of this section is considered timely if specified on a late-
filed return filed on or before the last day for making the election
under section 338.
(ii) New target in purchasing corporation's consolidated return.
If new target is includible for its first taxable year in a
consolidated return filed by the affiliated group of which the
purchasing corporation is a member on or before the last day for
making the election under section 338, any election or other action
that must be specified in a timely filed return for new target's
first taxable year (but which is not specified in the consolidated
return) is considered timely if specified in an amended return filed
on or before such last day, at the place where the consolidated
return was filed.
(4) Examples. The following examples illustrate this paragraph
(b): Example 1. T is an unaffiliated corporation with a tax year
ending March 31. At the close of September 20 of Year 1, P makes
a qualified stock purchase of T. P does not join in filing a
consolidated return. P makes a section 338 election for T on or
before June 15 of Year 2, which causes T's taxable year to end as
of the close of September 20 of Year 1. An income tax return for
T's taxable period ending on September 20 of Year 1 was due on
December 15 of Year 1. Additions to tax for failure to file a
return and to pay tax shown on a return will not be imposed if
T's return is filed and the tax paid on or before June 15 of Year
2. (This waiver applies even if the acquisition date coincides
with the last day of T's former taxable year, i.e., March 31 of
Year 2.) Interest on any underpayment of tax for old T's short
taxable year ending September 20 of Year 1 runs from December 15
of Year 1. A statement indicating that the waiver rule of this
paragraph is being asserted should be attached to T's return.
Example 2. Assume the same facts as in Example 1. Assume further
that new T adopts the calendar year by filing, on or before June 15
of Year 2, its first return (for the period beginning on September
21 of Year 1 and ending on December 31 of Year 1) indicating that a
calendar year is chosen. See §1.338- 1(b)(1). Any additions to
tax or amounts described in this paragraph (b) that arise because of
the late filing of a return for the period ending on December 31 of
Year 1 are waived, because they are based on circumstances that
would not exist but for the section 338 election. Notwithstanding
this waiver, however, the return is still considered due March 15 of
Year 2, and interest on any underpayment runs from that date.
Example 3. Assume the same facts as in Example 2, except that T's
former taxable year ends on October 31. Although prior to the
election old T had a return due on January 15 of Year 2 for its year
ending October 31 of Year 1, that return need not be filed because a
timely election under section 338 was made. Instead, old T must file
a final return for the period ending on September 20 of Year 1,
which is due on December 15 of Year 1. §1.338-10T [Removed]
Par. 6. Section 1.338-10T is removed.
Par. 7. Section 1.338(h)(10)-1 is added to read as follows:
§1.338(h)(10)-1 Deemed asset sale and liquidation.
(a) Scope. This section prescribes rules for qualification for a
section 338(h)(10) election and for making a section 338(h)(10)
election. This section also prescribes the consequences of such
election. The rules of this section are in addition to the rules of
§§1.338-1 through 1.338-10 and, in appropriate cases,
apply instead of the rules of §§1.338-1 through 1.338-10.
(b) Definitions--(1) Consolidated target. A consolidated target
is a target that is a member of a consolidated group within the
meaning of §1.1502-1(h) on the acquisition date and is not the
common parent of the group on that date.
(2) Selling consolidated group. A selling consolidated group is
the consolidated group of which the consolidated target is a member
on the acquisition date.
(3) Selling affiliate; affiliated target. A selling affiliate is
a domestic corporation that owns on the acquisition date an amount
of stock in a domestic target, which amount of stock is described in
section 1504(a)(2), and does not join in filing a consolidated
return with the target. In such case, the target is an affiliated
target.
(4) S corporation target. An S corporation target is a target
that is an S corporation immediately before the acquisition date.
(5) S corporation shareholders. S corporation shareholders are
the S corporation target's shareholders. Unless otherwise indicated,
a reference to S corporation shareholders refers both to S
corporation shareholders who do and those who do not sell their
target stock.
(6) Liquidation. Any reference in this section to a liquidation
is treated as a reference to the transfer described in paragraph (d)
(4) of this section notwithstanding its ultimate characterization
for Federal income tax purposes.
(c) Section 338(h)(10) election--
(1) In general. A section 338(h)(10) election may be made for T if P
acquires stock meeting the requirements of section 1504(a)(2) from a
selling consolidated group, a selling affiliate, or the S
corporation shareholders in a qualified stock purchase.
(2) Simultaneous joint election requirement. A section 338(h)(10)
election is made jointly by P and the selling consolidated group (or
the selling affiliate or the S corporation shareholders) on Form
8023 in accordance with the instructions to the form. S corporation
shareholders who do not sell their stock must also consent to the
election. The section 338(h)(10) election must be made not later
than the 15th day of the 9th month beginning after the month in
which the acquisition date occurs.
(3) Irrevocability. A section 338(h)(10) election is irrevocable.
If a section 338(h)(10) election is made for T, a section 338
election is deemed made for T.
(4) Effect of invalid election. If a section 338(h)(10) election
for T is not valid, the section 338 election for T is also not
valid.
(d) Certain consequences of section 338(h)(10) election. For
purposes of subtitle A of the Internal Revenue Code (except as
provided in §1.338-1(b)(2)), the consequences to the parties of
making a section 338(h)(10) election for T are as follows:
(1) P. P is automatically deemed to have made a gain recognition
election for its nonrecently purchased T stock, if any. The effect
of a gain recognition election includes a taxable deemed sale by P
on the acquisition date of any nonrecently purchased target stock.
See §1.338-5(d).
(2) New T. The AGUB for new T's assets is determined under
§1.338-5 and is allocated among the acquisition date assets
under §§1.338-6 and 1.338- 7. Notwithstanding paragraph
(d)(4) of this section (deemed liquidation of old T), new T remains
liable for the tax liabilities of old T (including the tax liability
for the deemed sale tax consequences). For example, new T remains
liable for the tax liabilities of the members of any consolidated
group that are attributable to taxable years in which those
corporations and old T joined in the same consolidated return. See
§1.1502-6(a).
(3) Old T--deemed sale--
(i) In general. Old T is treated as transferring all of its assets
to an unrelated person in exchange for consideration that includes
the discharge of its liabilities in a single transaction at the
close of the acquisition date (but before the deemed liquidation).
See §1.338-1(a) regarding the tax characterization of the
deemed asset sale. Except as provided in §1.338(h)(10)-1(d)(8)
(regarding the installment method), old T recognizes all of the gain
realized on the deemed transfer of its assets in consideration for
the ADSP. ADSP for old T is determined under §1.338-4 and
allocated among the acquisition date assets under
§§1.338-6 and 1.338-7. Old T realizes the deemed sale tax
consequences from the deemed asset sale before the close of the
acquisition date while old T is a member of the selling consolidated
group (or owned by the selling affiliate or owned by the S
corporation shareholders). If T is an affiliated target, or an S
corporation target, the principles of §§1.338- 2(c)(10)
and 1.338-10(a)(1), (5), and (6)(i) apply to the return on which the
deemed sale tax consequences are reported. When T is an S
corporation target, T's S election continues in effect through the
close of the acquisition date (including the time of the deemed
asset sale and the deemed liquidation) notwithstanding section
1362(d)(2)(B). Also, when T is an S corporation target (but not a
qualified subchapter S subsidiary), any direct and indirect
subsidiaries of T which T has elected to treat as qualified
subchapter S subsidiaries under section 1361(b)(3) remain qualified
subchapter S subsidiaries through the close of the acquisition date.
(ii) Tiered targets. In the case of parent-subsidiary chains of
corporations making elections under section 338(h)(10), the deemed
asset sale of a parent corporation is considered to precede that of
its subsidiary. See §1.338- 3(b)(4)(i).
(4) Old T and selling consolidated group, selling affiliate, or S
corporation shareholders--deemed liquidation; tax characterization--
(i) In general. Old T is treated as if, before the close of the
acquisition date, after the deemed asset sale in paragraph (d)(3) of
this section, and while old T is a member of the selling
consolidated group (or owned by the selling affiliate or owned by
the S corporation shareholders), it transferred all of its assets to
members of the selling consolidated group, the selling affiliate, or
S corporation shareholders and ceased to exist. The transfer from
old T is characterized for Federal income tax purposes in the same
manner as if the parties had actually engaged in the transactions
deemed to occur because of this section and taking into account
other transactions that actually occurred or are deemed to occur.
For example, the transfer may be treated as a distribution in
pursuance of a plan of reorganization, a distribution in complete
cancellation or redemption of all its stock, one of a series of
distributions in complete cancellation or redemption of all its
stock in accordance with a plan of liquidation, or part of a
circular flow of cash. In most cases, the transfer will be treated
as a distribution in complete liquidation to which section 336 or
337 applies.
(ii) Tiered targets. In the case of parent-subsidiary chains of
corporations making elections under section 338(h)(10), the deemed
liquidation of a subsidiary corporation is considered to precede the
deemed liquidation of its parent.
(5) Selling consolidated group, selling affiliate, or S
corporation shareholders--
(i) In general. If T is an S corporation target, S corporation
shareholders (whether or not they sell their stock) take their pro
rata share of the deemed sale tax consequences into account under
section 1366 and increase or decrease their basis in T stock under
section 1367. Members of the selling consolidated group, the selling
affiliate, or S corporation shareholders are treated as if, after
the deemed asset sale in paragraph (d)(3) of this section and before
the close of the acquisition date, they received the assets
transferred by old T in the transaction described in paragraph (d)
(4)(i) of this section. In most cases, the transfer will be treated
as a distribution in complete liquidation to which section 331 or
332 applies.
(ii) Basis and holding period of T stock not acquired. A member of
the selling consolidated group (or the selling affiliate or an S
corporation shareholder) retaining T stock is treated as acquiring
the stock so retained on the day after the acquisition date for its
fair market value. The holding period for the retained stock starts
on the day after the acquisition date. For purposes of this
paragraph, the fair market value of all of the T stock equals the
grossed-up amount realized on the sale to P of P's recently
purchased target stock. See §1.338-4(c).
(iii) T stock sale. Members of the selling consolidated group (or
the selling affiliate or S corporation shareholders) recognize no
gain or loss on the sale or exchange of T stock included in the
qualified stock purchase (although they may recognize gain or loss
on the T stock in the deemed liquidation).
(6) Nonselling minority shareholders other than nonselling S
corporation shareholders--
(i) In general. This paragraph (d)(6) describes the treatment of
shareholders of old T other than the following: members of the
selling consolidated group, the selling affiliate, S corporation
shareholders (whether or not they sell their stock), and P. For a
description of the treatment of S corporation shareholders, see
paragraph (d)(5) of this section. A shareholder to which this
paragraph (d)(6) applies is called a minority shareholder.
(ii) T stock sale. A minority shareholder recognizes gain or loss
on the shareholder's sale or exchange of T stock included in the
qualified stock purchase.
(iii) T stock not acquired. A minority shareholder does not
recognize gain or loss under this section with respect to shares of
T stock retained by the shareholder. The shareholder's basis and
holding period for that T stock is not affected by the section
338(h)(10) election.
(7) Consolidated return of selling consolidated group. If P
acquires T in a qualified stock purchase from a selling consolidated
group--
(i) The selling consolidated group must file a consolidated return
for the taxable period that includes the acquisition date;
(ii) A consolidated return for the selling consolidated group for
that period may not be withdrawn on or after the day that a section
338(h)(10) election is made for T; and
(iii) Permission to discontinue filing consolidated returns cannot
be granted for, and cannot apply to, that period or any of the
immediately preceding taxable periods during which consolidated
returns continuously have been filed.
(8) Availability of the section 453 installment method. Solely for
purposes of applying sections 453, 453A, and 453B, and the
regulations thereunder (the installment method) to determine the
consequences to old T in the deemed asset sale and to old T (and its
shareholders, if relevant) in the deemed liquidation, the rules in
paragraphs (d)(1) through (7) of this section are modified as
follows:
(i) In deemed asset sale. Old T is treated as receiving in the
deemed asset sale new T installment obligations, the terms of which
are identical (except as to the obligor) to P installment
obligations issued in exchange for recently purchased stock of T.
Old T is treated as receiving in cash all other consideration in the
deemed asset sale other than the assumption of, or taking subject
to, old T liabilities. For example, old T is treated as receiving in
cash any amounts attributable to the grossing-up of amount realized
under §1.338-4(c). The amount realized for recently purchased
stock taken into account in determining ADSP is adjusted (and, thus,
ADSP is redetermined) to reflect the amounts paid under an
installment obligation for the stock when the total payments under
the installment obligation are greater or less than the amount
realized.
(ii) In deemed liquidation. Old T is treated as distributing in
the deemed liquidation the new T installment obligations that it is
treated as receiving in the deemed asset sale. The members of the
selling consolidated group, the selling affiliate, or the S
corporation shareholders are treated as receiving in the deemed
liquidation the new T installment obligations that correspond to the
P installment obligations they actually received individually in
exchange for their recently purchased stock. The new T installment
obligations may be recharacterized under other rules. See for
example §1.453-11(a)(2) which, in certain circumstances, treats
the new T installment obligations deemed distributed by old T as if
they were issued by new T in exchange for the stock in old T owned
by members of the selling consolidated group, the selling affiliate,
or the S corporation shareholders. The members of the selling
consolidated group, the selling affiliate, or the S corporation
shareholders are treated as receiving all other consideration in the
deemed liquidation in cash.
(9) Treatment consistent with an actual asset sale. No provision
in section 338(h)(10) or this section shall produce a Federal income
tax result under subtitle A of the Internal Revenue Code that would
not occur if the parties had actually engaged in the transactions
deemed to occur because of this section and taking into account
other transactions that actually occurred or are deemed to occur.
See, however, §1.338-1(b)(2) for certain exceptions to this
rule.
(e) Examples. The following examples illustrate the provisions of
this section:
Example 1.
(i) S1 owns all of the T stock and T owns all of the stock of T1 and
T2. S1 is the common parent of a consolidated group that includes T,
T1, and T2. P makes a qualified stock purchase of all of the T stock
from S1. S1 joins with P in making a section 338(h)(10) election for
T and for the deemed purchase of T1. A section 338 election is not
made for T2.
(ii) S1 does not recognize gain or loss on the sale of the T stock
and T does not recognize gain or loss on the sale of the T1 stock
because section 338(h)(10) elections are made for T and T1. Thus,
for example, gain or loss realized on the sale of the T or T1 stock
is not taken into account in earnings and profits. However, because
a section 338 election is not made for T2, T must recognize any gain
or loss realized on the deemed sale of the T2 stock. See
§1.338-4(h).
(iii) The results would be the same if S1, T, T1, and T2 are not
members of any consolidated group, because S1 and T are selling
affiliates.
Example 2.
(i) S and T are solvent corporations. S owns all of the outstanding
stock of T. S and P agree to undertake the following transaction: T
will distribute half its assets to S, and S will assume half of T's
liabilities. Then, P will purchase the stock of T from S. S and P
will jointly make a section 338(h)(10) election with respect to the
sale of T. The corporations then complete the transaction as agreed.
(ii) Under section 338(a), the assets present in T at the close
of the acquisition date are deemed sold by old T to new T. Under
paragraph (d)(4) of this section, the transactions described in
paragraph (d) of this section are treated in the same manner as if
they had actually occurred. Because S and P had agreed that, after
T's actual distribution to S of part of its assets, S would sell T
to P pursuant to an election under section 338(h)(10), and because
paragraph (d)(4) of this section deems T subsequently to have
transferred all its assets to its shareholder, T is deemed to have
adopted a plan of complete liquidation under section 332. T's actual
transfer of assets to S is treated as a distribution pursuant to
that plan of complete liquidation.
Example 3.
(i) S1 owns all of the outstanding stock of both T and S2. All three
are corporations. S1 and P agree to undertake the following
transaction. T will transfer substantially all of its assets and
liabilities to S2, with S2 issuing no stock in exchange therefor,
and retaining its other assets and liabilities. Then, P will
purchase the stock of T from S1. S1 and P will jointly make a
section 338(h)(10) election with respect to the sale of T. The
corporations then complete the transaction as agreed.
(ii) Under section 338(a), the remaining assets present in T at
the close of the acquisition date are deemed sold by old T to new T.
Under paragraph (d)(4) of this section, the transactions described
in this section are treated in the same manner as if they had
actually occurred. Because old T transferred substantially all of
its assets to S2, and is deemed to have distributed all its
remaining assets and gone out of existence, the transfer of assets
to S2, taking into account the related transfers, deemed and actual,
qualifies as a reorganization under section 368(a)(1)(D). Section
361(c)(1) and not section 332 applies to T's deemed liquidation.
Example 4.
(i) T owns two assets: an actively traded security (Class II) with a
fair market value of $100 and an adjusted basis of $100, and
inventory (Class IV) with a fair market value of $100 and an
adjusted basis of $100. T has no liabilities. S is negotiating to
sell all the stock in T to P for $100 cash and contingent
consideration. Assume that under generally applicable tax accounting
rules, P's adjusted basis in the T stock immediately after the
purchase would be $100, because the contingent consideration is not
taken into account. Thus, under the rules of §1.338-5, AGUB
would be $100. Under the allocation rules of §1.338-6, the
entire $100 would be allocated to the Class II asset, the actively
traded security, and no amount would be allocated to the inventory.
P, however, plans immediately to cause T to sell the inventory, but
not the actively traded security, so it requests that, prior to the
stock sale, S cause T to create a new subsidiary, Newco, and
contribute the actively traded security to the capital of Newco.
Because the stock in Newco, which would not be actively traded, is a
Class V asset, under the rules of §1.338-6 $100 of AGUB would
be allocated to the inventory and no amount of AGUB would be
allocated to the Newco stock. Newco's own AGUB, $0 under the rules
of §1.338-5, would be allocated to the actively traded
security. When P subsequently causes T to sell the inventory, T
would realize no gain or loss instead of realizing gain of $100.
(ii) Assume that, if the T stock had not itself been sold but T
had instead sold both its inventory and the Newco stock to P, T
would for tax purposes be deemed instead to have sold both its
inventory and actively traded security directly to P, with P deemed
then to have created Newco and contributed the actively traded
security to the capital of Newco. Section 338, if elected, generally
recharacterizes a stock sale as a deemed sale of assets. However,
paragraph (d)(9) of this section states, in general, that no
provision of section 338(h)(10) or the regulations thereunder shall
produce a Federal income tax result under subtitle A of the Internal
Revenue Code that would not occur if the parties had actually
engaged in the transactions deemed to occur by virtue of the section
338(h)(10) election, taking into account other transactions that
actually occurred or are deemed to occur. Hence, the deemed sale of
assets under section 338(h)(10) should be treated as one of the
inventory and actively traded security themselves, not of the
inventory and Newco stock. The anti- abuse rule of §1.338-1(c)
does not apply, because the substance of the deemed sale of assets
is a sale of the inventory and the actively traded security
themselves, not of the inventory and the Newco stock. Otherwise, the
anti- abuse rule might apply.
Example 5.
(i) T, a member of a selling consolidated group, has only one class
of stock, all of which is owned by S1. On March 1 of Year 2, S1
sells its T stock to P for $80,000, and joins with P in making a
section 338(h)(10) election for T. There are no selling costs or
acquisition costs. On March 1 of Year 2, T owns land with a $50,000
basis and $75,000 fair market value and equipment with a $30,000
adjusted basis, $70,000 recomputed basis, and $60,000 fair market
value. T also has a $40,000 liability. S1 pays old T's allocable
share of the selling group's consolidated tax liability for Year 2
including the tax liability for the deemed sale tax consequences (a
total of $13,600). (ii) ADSP of $120,000 ($80,000 + $40,000 + 0) is
allocated to each asset as follows:
Assets Basis FMV Fraction ADSP
Allocable
Land ......... $50,000 $75,000 5/9 $66,667
Equipment .... 30,000 60,000 4/9 53,333
______ _______ ____ _______
Total.... $80,000 $135,000 1 $120,000
(iii) Under paragraph (d)(3) of this section, old T has gain on
the deemed sale of $40,000 (consisting of $16,667 of capital gain
and $23,333 of ordinary income).
(iv) Under paragraph (d)(5)(iii) of this section, S1 recognizes
no gain or loss upon its sale of the old T stock to P. S1 also
recognizes no gain or loss upon the deemed liquidation of T. See
paragraph (d)(4) of this section and section 332.
(v) P's basis in new T stock is P's cost for the stock, $80,000.
See section 1012.
(vi) Under §1.338-5, the AGUB for new T is $120,000, i.e.,
P's cost for the old T stock ($80,000) plus T's liability ($40,000).
This AGUB is allocated as basis among the new T assets under
§§1.338-6 and 1.338-7.
Example 6.
(i) The facts are the same as in Example 5, except that S1 sells 80
percent of the old T stock to P for $64,000, rather than 100 percent
of the old T stock for $80,000.
(ii) The consequences to P, T, and S1 are the same as in Example
5, except that:
(A) P's basis for its 80-percent interest in the new T stock is
P's $64,000 cost for the stock. See section 1012.
(B) Under §1.338-5, the AGUB for new T is $120,000 (i.e.,
$64,000/.8 + $40,000 + $0).
(C) Under paragraph (d)(4) of this section, S1 recognizes no gain
or loss with respect to the retained stock in T. See section 332.
(D) Under paragraph (d)(5)(ii) of this section, the basis of the T
stock retained by S1 is $16,000 (i.e., $120,000 ! ! $40,000 (the
ADSP amount for the old T assets over the sum of new T's liabilities
immediately after the acquisition date) ÷ .20 (the proportion
of T stock retained by S1)).
Example 7.
(i) The facts are the same as in Example 6, except that K, a
shareholder unrelated to T or P, owns the 20 percent of the T stock
that is not acquired by P in the qualified stock purchase. K's basis
in its T stock is $5,000.
(ii) The consequences to P, T, and S1 are the same as in Example
6.
(iii) Under paragraph (d)(6)(iii) of this section, K recognizes no
gain or loss, and K's basis in its T stock remains at $5,000.
Example 8.
(i) The facts are the same as in Example 5, except that the
equipment is held by T1, a wholly-owned subsidiary of T, and a
section 338(h)(10) election is also made for T1. The T1 stock has a
fair market value of $60,000. T1 has no assets other than the
equipment and no liabilities. S1 pays old T's and old T1's allocable
shares of the selling group's consolidated tax liability for Year 2
including the tax liability for T and T1's deemed sale tax
consequences.
(ii) ADSP for T is $120,000, allocated $66,667 to the land and
$53,333 to the stock. Old T's deemed sale results in $16,667 of
capital gain on its deemed sale of the land. Under paragraph (d)(5)
(iii) of this section, old T does not recognize gain or loss on its
deemed sale of the T1 stock. See section 332.
(iii) ADSP for T1 is $53,333 (i.e., $53,333 + $0 + $0). On the
deemed sale of the equipment, T1 recognizes ordinary income of
$23,333.
(iv) Under paragraph (d)(5)(iii) of this section, S1 does not
recognize gain or loss upon its sale of the old T stock to P.
Example 9.
(i) The facts are the same as in Example 8, except that P already
owns 20 percent of the T stock, which is nonrecently purchased stock
with a basis of $6,000, and that P purchases the remaining 80
percent of the T stock from S1 for $64,000.
(ii) The results are the same as in Example 8, except that under
paragraph (d)(1) of this section and §1.338-5(d), P is deemed
to have made a gain recognition election for its nonrecently
purchased T stock. As a result, P recognizes gain of $10,000 and its
basis in the nonrecently purchased T stock is increased from $6,000
to $16,000. P's basis in all the T stock is $80,000 (i.e., $64,000 +
$16,000). The computations are as follows:
(A) P's grossed-up basis for the recently purchased T stock is
$64,000 (i.e., $64,000 (the basis of the recently purchased T stock)
÷ (1 ! ! .2)/(.8) (the fraction in section 338(b)(4))).
(B) P's basis amount for the nonrecently purchased T stock is
$16,000 (i.e., $64,000 (the grossed-up basis in the recently
purchased T stock) ÷ (.2)/(1.0 ! .2) (the fraction in
section 338(b)(3)(B))).
(C) The gain recognized on the nonrecently purchased stock is
$10,000 (i.e., $16,000 ! ! $6,000).
Example 10.
(i) T is an S corporation whose sole class of stock is owned 40
percent each by A and B and 20 percent by C. T, A, B, and C all use
the cash method of accounting. A and B each has an adjusted basis of
$10,000 in the stock. C has an adjusted basis of $5,000 in the
stock. A, B, and C hold no installment obligations to which section
453A applies. On March 1 of Year 1, A sells its stock to P for
$40,000 in cash and B sells its stock to P for a $25,000 note issued
by P and real estate having a fair market value of $15,000. The
$25,000 note, due in full in Year 7, is not publicly traded and
bears adequate stated interest. A and B have no selling expenses.
T's sole asset is real estate, which has a value of $110,000 and an
adjusted basis of $35,000. Also, T's real estate is encumbered by
long-outstanding purchase-money indebtedness of $10,000. The real
estate does not have built-in gain subject to section 1374. A, B,
and C join with P in making a section 338(h)(10) election for T.
(ii) Solely for purposes of application of sections 453, 453A, and
453B, old T is considered in its deemed asset sale to receive back
from new T the $25,000 note (considered issued by new T) and $75,000
of cash (total consideration of $80,000 paid for all the stock sold,
which is then divided by .80 in the grossing-up, with the resulting
figure of $100,000 then reduced by the amount of the installment
note). Absent an election under section 453(d), gain is reported by
old T under the installment method.
(iii) In applying the installment method to old T's deemed asset
sale, the contract price for old T's assets deemed sold is $100,000,
the $110,000 selling price reduced by the indebtedness of $10,000 to
which the assets are subject. (The $110,000 selling price is itself
the sum of the $80,000 grossed-up in
paragraph (ii) above to $100,000 and the $10,000 liability.) Gross
profit is $75,000 ($110,000 selling price ! ! old T's basis of
$35,000). Old T's gross profit ratio is 0.75 (gross profit of
$75,000 ÷ $100,000 contract price). Thus, $56,250 (0.75
÷ the $75,000 cash old T is deemed to receive in Year 1) is
Year 1 gain attributable to the sale, and $18,750 ($75,000 !
! $56,250) is recovery of basis.
(iv) In its liquidation, old T is deemed to distribute the
$25,000 note to B, since B actually sold the stock partly for that
consideration. To the extent of the remaining liquidating
distribution to B, it is deemed to receive, along with A and C, the
balance of old T's liquidating assets in the form of cash. Under
section 453(h), B, unless it makes an election under section 453(d),
is not required to treat the receipt of the note as a payment for
the T stock; P's payment of the $25,000 note in Year 7 to B is a
payment for the T stock. Because section 453(h) applies to B, old
T's deemed liquidating distribution of the note is, under section
453B(h), not treated as a taxable disposition by old T.
(v) Under section 1366, A reports 40 percent, or $22,500, of old
T's $56,250 gain recognized in Year 1. Under section 1367, this
increases A's $10,000 adjusted basis in the T stock to $32,500.
Next, in old T's deemed liquidation, A is considered to receive
$40,000 for its old T shares, causing it to recognize an additional
$7,500 gain in Year 1.
(vi) Under section 1366, B reports 40 percent, or $22,500, of old
T's $56,250 gain recognized in Year 1. Under section 1367, this
increases B's $10,000 adjusted basis in its T stock to $32,500.
Next, in old T's deemed liquidation, B is considered to receive the
$25,000 note and $15,000 of other consideration. Applying section
453, including section 453(h), to the deemed liquidation, B's
selling price and contract price are both $40,000. Gross profit is
$7,500 ($40,000 selling price ! ! B's basis of $32,500). B's
gross profit ratio is 0.1875 (gross profit of $7,500 ÷
$40,000 contract price). Thus, $2,812.50 (0.1875 ÷ $15,000)
is Year 1 gain attributable to the deemed liquidation. In Year 7,
when the $25,000 note is paid, B has $4,687.50 (0.1875 ÷
$25,000) of additional gain.
(vii) Under section 1366, C reports 20 percent, or $11,250, of
old T's $56,250 gain recognized in Year 1. Under section 1367, this
increases C's $5,000 adjusted basis in its T stock to $16,250. Next,
in old T's deemed liquidation, C is considered to receive $20,000
for its old T shares, causing it to recognize an additional $3,750
gain in Year 1. Finally, under paragraph (d)(5)(ii) of this section,
C is considered to acquire its stock in T on the day after the
acquisition date for $20,000 (fair market value = grossed-up amount
realized of $100,000 ÷ 20%). C's holding period in the stock
deemed received in new T begins at that time.
(f) Inapplicability of provisions. The provisions of section 6043,
§1.331- 1(d), and §1.332-6 (relating to information
returns and recordkeeping requirements for corporate liquidations)
do not apply to the deemed liquidation of old T under paragraph (d)
(4) of this section.
(g) Required information. The Commissioner may exercise the
authority granted in section 338(h)(10)(C)(iii) to require provision
of any information deemed necessary to carry out the provisions of
section 338(h)(10) by requiring submission of information on any tax
reporting form. §1.338(h)(10)-1T [Removed]
Par. 8. Section 1.338(h)(10)-1T is removed.
Par. 9. Section 1.338(i)-1 is added to read as follows:
§1.338(i)-1 Effective dates.
(a) In general. The provisions of §§1.338-1 through
1.338-7, 1.338-10 and 1.338(h)(10)-1 apply to any qualified stock
purchase occurring after March 15, 2001. For rules applicable to
qualified stock purchases on or before March 15, 2001, see
§§1.338-1T through 1.338-7T, 1.338-10T, 1.338(h)(10)-1T
and 1.338(i)-1T in effect prior to March 16, 2001 (see 26 CFR part 1
revised April 1, 2000).
(b) Section 338(h)(10) elections for S corporation targets. The
requirements of §§1.338(h)(10)-1T(c)(2) and 1.338(h)
(10)-1(c)(2) that S corporation shareholders who do not sell their
stock must also consent to an election under section 338(h)(10) will
not invalidate an otherwise valid election made on the September
1997 revision of Form 8023, "Elections Under Section 338 For
Corporations Making Qualified Stock Purchases," not signed by the
nonselling shareholders, provided that the S corporation and all of
its shareholders (including nonselling shareholders) report the tax
consequences consistently with the results under section 338(h)(10).
§1.338(i)-1T [Removed]
Par. 10. Section 1.338(i)-1T is removed.
Par. 11. Section 1.1060-1 is added to read as follows:
§1.1060-1 Special allocation rules for certain asset
acquisitions.
(a) Scope--
(1) In general. This section prescribes rules relating to the
requirements of section 1060, which, in the case of an applicable
asset acquisition, requires the transferor (the seller) and the
transferee (the purchaser) each to allocate the consideration paid
or received in the transaction among the assets transferred in the
same manner as amounts are allocated under section 338(b)(5)
(relating to the allocation of adjusted grossed-up basis among the
assets of the target corporation when a section 338 election is
made). In the case of an applicable asset acquisition described in
paragraph (b)(1) of this section, sellers and purchasers must
allocate the consideration under the residual method as described in
§§1.338-6 and 1.338-7 in order to determine, respectively,
the amount realized from, and the basis in, each of the transferred
assets. For rules relating to distributions of partnership property
or transfers of partnership interests which are subject to section
1060(d), see §1.755-2T.
(2) Effective date. The provisions of this section apply to any
asset acquisition occurring after March 15, 2001. For rules
applicable to asset acquisitions on or before March 15, 2001, see
§1.1060-1T in effect prior to March 16, 2001 (see 26 CFR part 1
revised April 1, 2000).
(3) Outline of topics. In order to facilitate the use of this
section, this paragraph (a)(3) lists the major paragraphs in this
section as follows:
(a) Scope.
(1) In general.
(2) Effective date.
(3) Outline of topics.
(b) Applicable asset acquisition.
(1) In general.
(2) Assets constituting a trade or business.
(i) In general.
(ii) Goodwill or going concern value.
(iii) Factors indicating goodwill or going concern value.
(3) Examples.
(4) Asymmetrical transfers of assets.
(5) Related transactions.
(6) More than a single trade or business.
(7) Covenant entered into by the seller.
(8) Partial non-recognition exchanges.
(c) Allocation of consideration among assets under the residual
method.
(1) Consideration.
(2) Allocation of consideration among assets.
(3) Certain costs.
(4) Effect of agreement between parties.
(d) Examples.
(e) Reporting requirements.
(1) Applicable asset acquisitions.
(i) In general.
(ii) Time and manner of reporting.
(A) In general.
(B) Additional reporting requirement.
(2) Transfers of interests in partnerships.
(b) Applicable asset acquisition--
(1) In general. An applicable asset acquisition is any transfer,
whether direct or indirect, of a group of assets if the assets
transferred constitute a trade or business in the hands of either
the seller or the purchaser and, except as provided in paragraph (b)
(8) of this section, the purchaser's basis in the transferred assets
is determined wholly by reference to the purchaser's consideration.
(2) Assets constituting a trade or business--
(i) In general. For purposes of this section, a group of assets
constitutes a trade or business if--
(A) The use of such assets would constitute an active trade or
business under section 355; or
(B) Its character is such that goodwill or going concern value
could under any circumstances attach to such group.
(ii) Goodwill or going concern value. Goodwill is the value of a
trade or business attributable to the expectancy of continued
customer patronage. This expectancy may be due to the name or
reputation of a trade or business or any other factor. Going concern
value is the additional value that attaches to property because of
its existence as an integral part of an ongoing business activity.
Going concern value includes the value attributable to the ability
of a trade or business (or a part of a trade or business) to
continue functioning or generating income without interruption
notwithstanding a change in ownership. It also includes the value
that is attributable to the immediate use or availability of an
acquired trade or business, such as, for example, the use of the
revenues or net earnings that otherwise would not be received during
any period if the acquired trade or business were not available or
operational.
(iii) Factors indicating goodwill or going concern value. In
making the determination in this paragraph (b)(2), all the facts and
circumstances surrounding the transaction are taken into account.
Whether sufficient consideration is available to allocate to
goodwill or going concern value after the residual method is applied
is not relevant in determining whether goodwill or going concern
value could attach to a group of assets. Factors to be considered
include--
(A) The presence of any intangible assets (whether or not those
assets are section 197 intangibles), provided, however, that the
transfer of such an asset in the absence of other assets will not be
a trade or business for purposes of section 1060;
(B) The existence of an excess of the total consideration over the
aggregate book value of the tangible and intangible assets purchased
(other than goodwill and going concern value) as shown in the
financial accounting books and records of the purchaser; and
(C) Related transactions, including lease agreements, licenses, or
other similar agreements between the purchaser and seller (or
managers, directors, owners, or employees of the seller) in
connection with the transfer.
(3) Examples. The following examples illustrate paragraphs (b)(1)
and (2) of this section:
Example 1. S is a high grade machine shop that manufactures
microwave connectors in limited quantities. It is a successful
company with a reputation within the industry and among its
customers for manufacturing unique, high quality products. Its
tangible assets consist primarily of ordinary machinery for working
metal and plating. It has no secret formulas or patented drawings of
value. P is a company that designs, manufactures, and markets
electronic components. It wants to establish an immediate presence
in the microwave industry, an area in which it previously has not
been engaged. P is acquiring assets of a number of smaller companies
and hopes that these assets will collectively allow it to offer a
broad product mix. P acquires the assets of S in order to augment
its product mix and to promote its presence in the microwave
industry. P will not use the assets acquired from S to manufacture
microwave connectors. The assets transferred are assets that
constitute a trade or business in the hands of the seller. Thus, P's
purchase of S's assets is an applicable asset acquisition. The fact
that P will not use the assets acquired from S to continue the
business of S does not affect this conclusion.
Example 2. S, a sole proprietor who operates a car wash, both
leases the building housing the car wash and sells all of the car
wash equipment to P. S's use of the building and the car wash
equipment constitute a trade or business. P begins operating a car
wash in the building it leases from S. Because the assets
transferred together with the asset leased are assets which
constitute a trade or business, P's purchase of S's assets is an
applicable asset acquisition.
Example 3. S, a corporation, owns a retail store business in State
X and conducts activities in connection with that business
enterprise that meet the active trade or business requirement of
section 355. P is a minority shareholder of S. S distributes to P
all the assets of S used in S's retail business in State X in
complete redemption of P's stock in S held by P. The distribution of
S's assets in redemption of P's stock is treated as a sale or
exchange under sections 302(a) and 302(b)(3), and P's basis in the
assets distributed to it is determined wholly by reference to the
consideration paid, the S stock. Thus, S's distribution of assets
constituting a trade or business to P is an applicable asset
acquisition.
Example 4. S is a manufacturing company with an internal financial
bookkeeping department. P is in the business of providing a
financial bookkeeping service on a contract basis. As part of an
agreement for P to begin providing financial bookkeeping services to
S, P agrees to buy all of the assets associated with S's internal
bookkeeping operations and provide employment to any of S's
bookkeeping department employees who choose to accept a position
with P. In addition to selling P the assets associated with its
bookkeeping operation, S will enter into a long term contract with P
for bookkeeping services. Because assets transferred from S to P,
along with the related contract for bookkeeping services, are a
trade or business in the hands of P, the sale of the bookkeeping
assets from S to P is an applicable asset acquisition.
(4) Asymmetrical transfers of assets. A purchaser is subject to
section 1060 if--
(i) Under general principles of tax law, the seller is not
treated as transferring the same assets as the purchaser is treated
as acquiring;
(ii) The assets acquired by the purchaser constitute a trade or
business; and
(iii) Except as provided in paragraph (b)(8) of this section, the
purchaser's basis in the transferred assets is determined wholly by
reference to the purchaser's consideration.
(5) Related transactions. Whether the assets transferred
constitute a trade or business is determined by aggregating all
transfers from the seller to the purchaser in a series of related
transactions. Except as provided in paragraph (b)(8) of this
section, all assets transferred from the seller to the purchaser in
a series of related transactions are included in the group of assets
among which the consideration paid or received in such series is
allocated under the residual method. The principles of
§1.338-1(c) are also applied in determining which assets are
included in the group of assets among which the consideration paid
or received is allocated under the residual method.
(6) More than a single trade or business. If the assets
transferred from a seller to a purchaser include more than one trade
or business, then, in applying this section, all of the assets
transferred (whether or not transferred in one transaction or a
series of related transactions and whether or not part of a trade or
business) are treated as a single trade or business.
(7) Covenant entered into by the seller. If, in connection with an
applicable asset acquisition, the seller enters into a covenant
(e.g., a covenant not to compete) with the purchaser, that covenant
is treated as an asset transferred as part of a trade or business.
(8) Partial non-recognition exchanges. A transfer may constitute
an applicable asset acquisition notwithstanding the fact that no
gain or loss is recognized with respect to a portion of the group of
assets transferred. All of the assets transferred, including the
non-recognition assets, are taken into account in determining
whether the group of assets constitutes a trade or business. The
allocation of consideration under paragraph (c) of this section is
done without taking into account either the non-recognition assets
or the amount of money or other property that is treated as
transferred in exchange for the non-recognition assets (together,
the non-recognition exchange property). The basis in and gain or
loss recognized with respect to the non-recognition exchange
property are determined under such rules as would otherwise apply to
an exchange of such property. The amount of the money and other
property treated as exchanged for non-recognition assets is the
amount by which the fair market value of the non- recognition assets
transferred by one party exceeds the fair market value of the non-
recognition assets transferred by the other (to the extent of the
money and the fair market value of property transferred in the
exchange). The money and other property that are treated as
transferred in exchange for the non-recognition assets (and which
are not included among the assets to which section 1060 applies) are
considered to come from the following assets in the following order:
first from Class I assets, then from Class II assets, then from
Class III assets, then from Class IV assets, then from Class V
assets, then from Class VI assets, and then from Class VII assets.
For this purpose, liabilities assumed (or to which a non-recognition
exchange property is subject) are treated as Class I assets. See
Example 1 in paragraph (d) of this section for an example of the
application of section 1060 to a single transaction which is, in
part, a non- recognition exchange.
(c) Allocation of consideration among assets under the residual
method -- (1) Consideration. The seller's consideration is the
amount, in the aggregate, realized from selling the assets in the
applicable asset acquisition under section 1001(b). The purchaser's
consideration is the amount, in the aggregate, of its cost of
purchasing the assets in the applicable asset acquisition that is
properly taken into account in basis.
(2) Allocation of consideration among assets. For purposes of
determining the seller's amount realized for each of the assets sold
in an applicable asset acquisition, the seller allocates
consideration to all the assets sold by using the residual method
under §§1.338-6 and 1.338-7, substituting consideration
for ADSP. For purposes of determining the purchaser's basis in each
of the assets purchased in an applicable asset acquisition, the
purchaser allocates consideration to all the assets purchased by
using the residual method under §§1.338-6 and 1.338-7,
substituting consideration for AGUB. In allocating consideration,
the rules set forth in paragraphs (c)(3) and (4) of this section
apply in addition to the rules in §§1.338-6 and 1.338-7.
(3) Certain costs. The seller and purchaser each adjusts the
amount allocated to an individual asset to take into account the
specific identifiable costs incurred in transferring that asset in
connection with the applicable asset acquisition (e.g., real estate
transfer costs or security interest perfection costs). Costs so
allocated increase, or decrease, as appropriate, the total
consideration that is allocated under the residual method. No
adjustment is made to the amount allocated to an individual asset
for general costs associated with the applicable asset acquisition
as a whole or with groups of assets included therein (e.g., non-
specific appraisal fees or accounting fees). These latter amounts
are taken into account only indirectly through their effect on the
total consideration to be allocated.
(4) Effect of agreement between parties. If, in connection with an
applicable asset acquisition, the seller and purchaser agree in
writing as to the allocation of any amount of consideration to, or
as to the fair market value of, any of the assets, such agreement is
binding on them to the extent provided in this paragraph (c)(4).
Nothing in this paragraph (c)(4) restricts the Commissioner's
authority to challenge the allocations or values arrived at in an
allocation agreement. This paragraph (c)(4) does not apply if the
parties are able to refute the allocation or valuation under the
standards set forth in Commissioner v. Danielson, 378 F.2d 771 (3d
Cir.), cert. denied, 389 U.S. 858 (1967) (a party wishing to
challenge the tax consequences of an agreement as construed by the
Commissioner must offer proof that, in an action between the parties
to the agreement, would be admissible to alter that construction or
show its unenforceability because of mistake, undue influence,
fraud, duress, etc.).
(d) Examples. The following examples illustrate this section:
Example 1.
(i) On January 1, 2001, A transfers assets X, Y, and Z to B in
exchange for assets D, E, and F plus $1,000 cash.
(ii) Assume the exchange of assets constitutes an exchange of like-
kind property to which section 1031 applies. Assume also that
goodwill or going concern value could under any circumstances attach
to each of the DEF and XYZ groups of assets and, therefore, each
group constitutes a trade or business under section 1060. (iii)
Assume the fair market values of the assets and the amount of money
transferred are as follows:
By A By B Asset Fair Asset Fair
Market Market
Value Value
X..................$400 D ............ $40
Y.................. 400 E ..............30
Z ..................200 F ..............30
Cash (amount) ....... 1,000
Total.......... $ 1,000 Total ......$1,100
(iv) Under paragraph (b)(8) of this section, for purposes of
allocating consideration under paragraph (c) of this section, the
like-kind assets exchanged and any money or other property that are
treated as transferred in exchange for the like-kind property are
excluded from the application of section 1060.
(v) Since assets X, Y, and Z are like-kind property, they are
excluded from the application of the section 1060 allocation rules.
(vi) Since assets D, E, and F are like-kind property, they are
excluded from the application of the section 1060 allocation rules.
Thus, the allocation rules of section 1060 do not apply in
determining B's gain or loss with respect to the disposition of
assets D, E, and F, and the allocation rules of section 1060 and
paragraph (c) of this section are not applied to determine A's bases
of assets D, E, and F. In addition, $900 of the $1,000 cash B gave
to A for A's like-kind assets (X, Y, and Z) is treated as
transferred in exchange for the like-kind property in order to
equalize the fair market values of the like-kind assets. Therefore,
$900 of the cash is excluded from the application of the section
1060 allocation rules.
(vii) $100 of the cash is allocated under section 1060 and
paragraph (c) of this section.
(viii) A received $100 that must be allocated under section 1060
and paragraph (c) of this section. Since A transferred no Class I,
II, III, IV, V, or VI assets to which section 1060 applies, in
determining its amount realized for the part of the exchange to
which section 1031 does not apply, the $100 is allocated to Class
VII assets (goodwill and going concern value).
(ix) B gave A $100 that must be allocated under section 1060 and
paragraph (c) of this section. Since B received from A no Class I,
II, III, IV, V, or VI assets to which section 1060 applies, the $100
consideration is allocated by B to Class VII assets (goodwill and
going concern value). Example 2.
(i) On January 1, 2001, S, a sole proprietor, sells to P, a
corporation, a group of assets that constitutes a trade or business
under paragraph (b)(2) of this section. S, who plans to retire
immediately, also executes in P's favor a covenant not to compete. P
pays S $3,000 in cash and assumes $1,000 in liabilities. Thus, the
total consideration is $4,000.
(ii) On the purchase date, P and S also execute a separate
agreement that states that the fair market values of the Class II,
Class III, Class V, and Class VI assets S sold to P are as follows:
Asset Asset Fair
Class Market
Value
II Actively traded securities .............. $500
____
Total Class II .................. 500
III Accounts receivable .................. 200
____
Total Class III.................. 200
V Furniture and fixtures ................. 800
Building............................ 800
Land .............................. 200
Equipment ......................... 400
____
Total Class V .................. 2,200
VI Covenant not to compete .............. 900
___
Total Class VI ................. 900
(iii) P and S each allocate the consideration in the transaction
among the assets transferred under paragraph (c) of this section in
accordance with the agreed upon fair market values of the assets, so
that $500 is allocated to Class II assets, $200 is allocated to the
Class III asset, $2,200 is allocated to Class V assets, $900 is
allocated to Class VI assets, and $200 ($4,000 total consideration
less $3,800 allocated to assets in Classes II, III, V, and VI) is
allocated to the Class VII assets (goodwill and going concern
value).
(iv) In connection with the examination of P's return, the
Commissioner, in determining the fair market values of the assets
transferred, may disregard the parties' agreement. Assume that the
Commissioner correctly determines that the fair market value of the
covenant not to compete was $500. Since the allocation of
consideration among Class II, III, V, and VI assets results in
allocation up to the fair market value limitation, the $600 of
unallocated consideration resulting from the Commissioner's
redetermination of the value of the covenant not to compete is
allocated to Class VII assets (goodwill and going concern value).
(e) Reporting requirements--(1) Applicable asset acquisitions--
(i) In general. Unless otherwise excluded from this requirement by
the Commissioner, the seller and the purchaser in an applicable
asset acquisition each must report information concerning the amount
of consideration in the transaction and its allocation among the
assets transferred. They also must report information concerning
subsequent adjustments to consideration.
(ii) Time and manner of reporting--(A) In general. The seller and
the purchaser each must file asset acquisition statements on Form
8594, "Asset Allocation Statement," with their income tax returns or
returns of income for the taxable year that includes the first date
assets are sold pursuant to an applicable asset acquisition. This
reporting requirement applies to all asset acquisitions described in
this section. For reporting requirements relating to asset
acquisitions occurring before March 16, 2001, as described in
paragraph (a)(2) of this section, see the temporary regulations
under section 1060 in effect prior to March 16, 2001 (see 26 CFR
part 1 revised April 1, 2000).
(B) Additional reporting requirement. When an increase or decrease
in consideration is taken into account after the close of the first
taxable year that includes the first date assets are sold in an
applicable asset acquisition, the seller and the purchaser each must
file a supplemental asset acquisition statement on Form 8594 with
the income tax return or return of income for the taxable year in
which the increase (or decrease) is properly taken into account.
(2) Transfers of interests in partnerships. For reporting
requirements relating to the transfer of a partnership interest, see
§1.755-2T(c). §1.1060-1T [Removed]
Par. 12. Section 1.1060-1T is removed.
Par. 13. Section 1.1361-1 is amended as follows:
1. Redesignate paragraph (l)(2)(v) as paragraph (l)(2)(vi).
2. Add a new paragraph (l)(2)(v).
The addition reads as follows: §1.1361-1 S corporation
defined.
* * * * *
(l) * * *
(2) * * *
(v) Special rule for section 338(h)(10) elections. If the
shareholders of an S corporation sell their stock in a transaction
for which an election is made under section 338(h)(10) and
§1.338(h)(10)-1, the receipt of varying amounts per share by
the shareholders will not cause the S corporation to have more than
one class of stock, provided that the varying amounts are determined
in arm's length negotiations with the purchaser.
* * * * *
Par. 14. Section 1.1361-4 is amended by removing the last two
sentences of paragraph (b)(4) and adding three sentences to read as
follows: §1.1361-4 Effect of QSub election.
* * * * *
(b) * * *
(4) Coordination with section 338 election. * * * If an S
corporation makes an election under section 338 (without a section
338(h)(10) election) with respect to a target, the target must file
a final return as a C corporation reflecting the deemed sale. See
§1.338-10(a). If the target was an S corporation on the day
before the acquisition date, the final return as a C corporation
must reflect the activities of the target for the acquisition date,
including the deemed sale. See §1.338-10(a)(3).
* * * * *
Par. 15. Section 1.1502-76 is amended by adding a parenthetical
at the end of paragraph (b)(1)(ii)(B)(3) and before the semicolon to
read as follows: §1.1502-76 Taxable year of members of group.
* * * * *
(b) * * *
(1) * * *
(ii) * * *
(B) * * *
(3) * * * (but see §1.338-1(d)) * * *
* * * * *
PART 602--OMB CONTROL NUMBERS UNDER PAPERWORK REDUCTION ACT
Par. 16. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 17. In §602.101, paragraph (b) is amended by removing the
entries for §§1.338-2T, 1.338-5T, 1.338-10T, 1.338(h)
(10)-1T, and 1.1060-1T from the table and adding new entries to the
table in numerical order to read as follows: §602.101 OMB
Control numbers.
* * * * *
(b) * * *
________________________________________________________________
CFR part or section where Current OMB
identified and described control No.
________________________________________________________________
* * * * *
1.338-2 . . . . . . . . . . . . . . . . . . . . . . 1545-1658
1.338-5 . . . . . . . . . . . . . . . . . . . . . . 1545-1658
1.338-10 . . . . . . . . . . . . .. . . . . . . . . 1545-1658
1.338(h)(10)-1 . . . . . . . . . .. . . . . . . . 1545-1658
* * * * *
1.1060-1 . . . . . . . . . . . . .. . . . . . . . . 1545-1658
* * * * *
Robert E. Wenzel
Deputy Commissioner of Internal Revenue.
Approved: January 4, 2001
Jonathan Talisman
Assistant Secretary of the Treasury (Tax Policy).
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