Updated Guidance on the Determination of Basis of Stock in Transferred Basis Transactions

Editor: Mark G. Cook, CPA, MBA

Corporations & Shareholders

Rev. Proc. 2011-35 was issued in response to the increasing difficulty of determining the transferred basis in stock associated with type B reorganizations as defined in Sec. 368(a)(1)(B), particularly when the stock is publicly traded. Under Sec. 368(a)(1)(B), a type B reorganization is a corporate acquisition where an exchange of all or part of voting stock occurs in order to gain a controlling interest in the target corporation. Rev. Proc. 2011-35 provides four safe-harbor methodologies that a corporation may use to establish its basis in the stock of another corporation in a type B reorganization or certain other transferred basis transactions.

This most recent revenue procedure updates and clarifies Rev. Proc. 81-70, Notice 2004-44, and Notice 2009-4. Rev. Proc. 81-70 established that the most effective way for the acquirer to determine the target stock’s transferred basis is to survey the target shareholders’ basis in their stock at time of surrender, in conjunction with statistical sampling guidelines. However, securities market operations have changed considerably since the issuance of Rev. Proc. 81-70.

The most significant change in the current market is that stock is typically held by nominees (i.e., clearinghouses or financial institutions) that are required to maintain the confidentiality of their clients’ identities. This created a challenge to effectively survey the target shareholders, thus making it very difficult to determine the transferred basis in the current market. Notice 2004-44 and Notice 2009-4 identified and confirmed the need for a revision of Rev. Proc. 81-70. Rev. Proc. 2011-35 adopts the safe harbors offered in Notice 2009-4 but has been altered to allow the use of data easily accessible to the acquiring corporations (discussed below). Finally, Rev. Proc. 2011-35 allows the applicability of the valuation methodologies to all transferred basis transactions beyond type B reorganizations, such as Sec. 351 exchanges and some triangular reorganizations.

Rev. Proc. 2011-35

The primary purpose of Rev. Proc. 2011-35 is to provide detailed guidance on the four methodologies that are available to determine the carryover basis in transferred stock, applying the safe harbors of Notice 2009-4 as follows:

• A full survey for shares surrendered either by the shareholder or by the nominee on behalf of the reporting shareholders;
• A combination of statistical sampling and survey for the target shareholders or nominee;
• A valuation model using data from the stock registry and trading activity for registered, nonreporting shareholders; and
• A valuation model for surrendering nominee shareholders using public trading data.

All four methodologies can be used in conjunction to achieve the most accurate basis estimate of the transferred shares.

The revenue procedure has provided additional guidelines to calculate specific limitations that apply to prevent the skewing of data when determining carryover basis. For example, a limitation will be imposed if statistical sampling is used and specific statistical confidence levels are not achieved during the valuation process (i.e., the least advantageous 95% one-sided confidence limit). Alternatively, if the basis model method is used, a limitation may be imposed in the form of the percentage of the uncollected data within a given collection period (e.g., if data from only 54 of the 60 measuring dates were collected, the allowable basis in a share is equal to 90% of the modeled basis (54 ÷ 60 = 90%)). The IRS has reserved the right to make further limitations if it is determined that the estimations do not factor in material omissions due to the uncollected data.

Taxpayers acquiring stock in transferred basis transactions described in this revenue procedure are deemed to satisfy the reporting requirements of Regs. Secs. 1.351-3 and 1.368-3 if they include a statement on or with the timely filed original return for the tax year of the transferred basis transaction that identifies the transaction and states that a basis study is pending with respect to the acquired stock. Taxpayers must include complete statements as required under the regulations, with the basis determined in accordance with the methodologies of Rev. Proc. 2011-35, on or with the timely filed tax return for a tax year that is no later than the tax year that includes the date that is two years after the date of the transferred basis transaction.

Rev. Proc. 2011-35 was issued on June 20, 2011, and is effective for all transferred basis transactions completed on or after that date. Early application of Rev. Proc. 2011-35 is permitted for transactions completed before the issuance date; however, in such cases surveys will be considered timely if substantially completed, and reporting requirements will be considered satisfied if filed on or before June 20, 2013.

EditorNotes

Mark Cook is a partner at SingerLewak LLP in Irvine, CA.

The editor would like to offer a special thanks to Christian J. Burgos, J.D., LL.M., for his assistance with this column.

For additional information about these items, contact Mr. Cook at (949) 261-8600, ext. 2143, or mcook@singerlewak.com.

Unless otherwise noted, contributors are members of or associated withSingerLewak LLP.