Consolidated Returns
The IRS recently proposed revisions (REG-133002-10) to the consolidated return regulations on the application of Sec. 382 and calculation of net unrealized built-in gains (NUBIGs) and losses (NUBILs). The proposed regulations would modify the current regulations under Regs. Sec. 1.1502-91(g) by requiring corporations filing consolidated returns to redetermine consolidated NUBIG and NUBIL on certain unduplicated gain or loss in the stock of included subsidiaries taken into account during the recognition period.
Background to Sec. 382
Sec. 382 was enacted to prevent trafficking in tax net operating losses. Sec. 382(b)(1) limits the ability of a loss corporation to utilize its net operating losses that arose before an ownership change against income earned in postchange tax years. The amount of prechange loss that can be used in a postchange year is limited by the loss corporation’s Sec. 382 limitation, which is defined under Sec. 382(b)(1) as the value of the loss corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate. A loss corporation with a NUBIG in its assets immediately before an ownership change may generally increase its Sec. 382 limitation to the extent of its NUBIG by built-in gains recognized during the five-year postchange recognition period under Sec. 382(h)(1)(A). A loss corporation with a NUBIL in its assets immediately before an ownership change, on the other hand, must generally treat built-in losses recognized during the five-year postchange recognition period as if such losses, to the extent of NUBIL, were prechange losses subject to the Sec. 382 limitation.
NUBIG/NUBIL is measured under Sec. 382(h)(3)(A)(i) as the amount by which the fair market value (FMV) of the loss corporation’s assets immediately before the ownership change is more than or less than the aggregate adjusted tax basis of such assets. The calculated NUBIG or NUBIL is treated as if it is zero unless it exceeds a threshold requirement under Sec. 382(h)(3)(B), which is the lesser of $10 million or 15% of the FMV of the loss corporation’s assets (not including cash and cash-like items) immediately before the ownership change. Thus, corporations seeking to maximize the use of losses generally prefer a NUBIG to a NUBIL, or if the corporation is in a NUBIL position, such corporations prefer the smallest NUBIL possible.
Current Regulations
The current regulations under Regs. Sec. 1.1502-91(g) provide that the determination of whether a consolidated group has a NUBIG or NUBIL is based on the aggregate amount of the separately computed NUBIGs or NUBILs of each member that is included in the consolidated group. The current regulations further provide that the separately computed NUBIG or NUBIL amount of a member included in a group does not include any unrealized built-in gain or loss on stock of another member included in the group.
Example 1: X is the common parent of a consolidated group, and X’s only asset is all of the outstanding stock of group member Y1. (See Regs. Sec. 1.1502-91(g)(8), Example 1.) Y1 in turn owns all of the outstanding stock of group member Y2 and a truck with an FMV of $80 and an adjusted tax basis of $70. Y2’s only asset is all of the outstanding stock of Y3. Y3’s only assets are a car and a bike. Y3’s car has an FMV of $40 and an adjusted tax basis of $70. Y3’s bike has an FMV of $40 and an adjusted tax basis of $30.
In this example, the X group’s NUBIL is $10 (the sum of the separate company NUBIG/NUBIL of each group member, which is $0 for X, a $10 NUBIG for Y1, $0 for Y2, and a $20 NUBIL for Y3). Note that the current regulations provide that the unrecognized built-in gain or loss in the stock of each included member in this example, Y1, Y2, and Y3, is not taken into account for purposes of determining the X group’s NUBIG or NUBIL.
The IRS notes in the preamble to the proposed regulations that this rule in the current regulations is premised upon the observation that unrecognized gain or loss on included subsidiary stock generally reflects the same economic gain or loss as in the subsidiary’s assets, and the consolidated return regulations generally prevent the group from taking that duplicative gain or loss into account more than once. For example, Regs. Sec. 1.1502-32 generally eliminates duplicative gain or loss reflected in stock basis, and Regs. Sec. 1.1502-36 generally eliminates duplicative asset loss. Consequently, under the current regulations, and consistent with the IRS’s observation of such regulations, NUBIG and NUBIL do not include any unrealized built-in gain or loss on stock of another member included in the group because such amounts are typically already reflected in the assets of such member, and consequently, NUBIG or NUBIL would be distorted if the same economic gain or loss were included more than once.
Proposed Regulations
In some situations, however, the unrecognized gain or loss in subsidiary stock may exceed the gain or loss in such group member’s assets. The IRS expressed its concern in the preamble to the proposed regulations that disregarding this unduplicated gain or loss in the stock of the group member in the NUBIG/NUBIL calculation understates the true amount that the group may take into account.
Example 2: P, the common parent of an affiliated group that has elected to file consolidated tax returns, undergoes a Sec. 382 ownership change. At the time of the ownership change, P’s only asset is all of the outstanding stock in Q, which has a value of $200 and a basis of $450. Q holds assets with a value of $200 and a basis of $350.
Under the current regulations, the P group’s NUBIL is $150 (ignoring for purposes of this example the threshold requirement of Sec. 382(h)(3)(B)), which corresponds to the built-in loss in Q’s assets. The actual loss available to the group, however, is $250 (P’s built-in loss in the Q stock). Of this $250 amount, $150 is a “duplicated loss” because it is reflected in the basis of both the Q stock and the Q assets. The remaining $100 is an “unduplicated loss” not reflected in Q’s assets and therefore not reflected in the NUBIL calculation at the time of the ownership change. The proposed regulations are intended to mitigate the impact of the $100 understatement of NUBIL in this example.
An understated NUBIL is generally favorable to the taxpayer but inappropriate from an IRS perspective because recognized built-in losses during the postchange recognition period are treated as prechange losses subject to the Sec. 382 limitation only to the extent of the loss corporation’s NUBIL. Thus, the IRS appears to be concerned that an understated NUBIL may allow a loss corporation to improperly use losses that are properly attributable to the prechange period. This concern is amplified when a group with an overall NUBIG sells built-in loss stock of an included member during a postchange recognition period. In this scenario, even if the group would have been in a NUBIL position had the unduplicated built-in stock loss been taken into account in determining NUBIL, none of the loss on the stock disposition is treated as a prechange loss subject to the Sec. 382 limitation under the current regulations.
Example 3: A, the common parent of an affiliated group that has elected to file consolidated tax returns, undergoes a Sec. 382 ownership change. At the time of the ownership change, A’s only asset is all of the outstanding stock in B, which has a value of $200 and a basis of $600. B holds assets with a value of $200 and a basis of $150.
Under current regulations, the A group’s NUBIG is $50 (ignoring for purposes of this example the threshold requirement of Sec. 382(h)(3)(B)), which corresponds to the built-in gain in B’s assets. If A sells its stock in B for a loss of $400, the group’s NUBIG/NUBIL is not redetermined under the current regulations, even though the built-in loss on the B stock existed at the time of the ownership change. Consequently, absent a change to the existing rules, the A group’s $400 loss is not treated as a recognized built-in loss subject to its Sec. 382 limitation.
In response, the proposed regulations require the unduplicated gain or loss in the stock of included subsidiaries to be taken into account in calculating NUBIG and NUBIL to the extent that such unduplicated gain or loss is taken into account by the group during the recognition period. Generally, this occurs with respect to stock of a member with an unduplicated gain or loss only if (1) such stock is sold to a nonmember, (2) such stock becomes worthless, or (3) a group member takes an intercompany item into account with respect to such stock. Thus, the proposed regulations do not require an immediate inclusion of unduplicated built-in stock gain or loss in the NUBIG/NUBIL calculation, but instead delay the calculation and require a redetermination of NUBIG/NUBIL when one of these three triggering events occurs. Therefore, taxpayers must redetermine NUBIG/NUBIL each time an unduplicated built-in gain or loss with respect to the subsidiary stock is taken into account. The term “unduplicated built-in gain or loss,” as used in the proposed regulations, refers to the portion of the built-in stock gain or loss that originally was not reflected in the loss group’s NUBIG or NUBIL.
Example 4: Assume the same facts as in Example 2, where the P group’s NUBIL at the time of the ownership change is $150.
Under the proposed regulations, if P sells its stock in Q for $200 during the postchange recognition period, thereby triggering a $250 loss, the P group must redetermine its NUBIL. The P group’s redetermined NUBIL is $250, which now takes into account the $100 of unduplicated built-in stock loss in the Q stock.
The redetermined NUBIG or NUBIL under the proposed regulations does not change the treatment of built-in gain or loss recognized before the time of the redetermination. Thus, the redetermined NUBIG or NUBIL is given effect only immediately before the gain or loss on the stock is taken into account.
Example 5: D, the common parent of an affiliated group that has elected to file consolidated tax returns, undergoes a Sec. 382 ownership change at the end of year 1. The consolidated group has a NUBIG immediately before the ownership change. (However, there is a built-in loss in the outside basis in the stock of a member subsidiary.) In year 3, D triggers a built-in loss in a nonstock asset within the consolidated group, but D is in a NUBIG position, so the built-in loss on the asset is not treated as a prechange loss subject to D’s Sec. 382 limitation. In year 4, D triggers a built-in loss on the sale of the member subsidiary stock that had the built-in loss as of the change date.
Under the proposed regulations, D redetermines its NUBIG/NUBIL in year 4 and is now in an overall NUBIL position because of the unduplicated built-in stock loss in the subsidiary. The year 4 stock sale and NUBIG/NUBIL redetermination do not change the treatment of the year 3 asset sale when the D group was in a NUBIG position.
Under the current regulations and absent the proposed regulations, taxpayers faced with the unfavorable scenario of an unduplicated built-in stock loss may take steps to avoid triggering the unduplicated loss. For example, such taxpayers may avoid the duplicated built-in loss by eliminating the stock in a Sec. 332 liquidation, selling assets instead of stock, or making a Sec. 338 election. Overall, the proposed regulations attempt to draw a balance between maintaining the original purpose of Sec. 382 to prevent loss trafficking and administrative ease. The proposed regulations do not require an immediate inclusion of unduplicated built-in stock gain or loss in the NUBIG/NUBIL calculation and instead delay the redetermination until such gain or loss is actually taken into account.
Effective Date
The proposed regulations will apply only to amounts taken into account with respect to a share of stock of an included subsidiary on or after the date that the proposed regulations are published as final regulations in the Federal Register. In addition, once the proposed regulations are published as final, they will apply only with respect to ownership changes occurring on or after October 24, 2011.
EditorNotes
Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, DC.
For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or greg.fairbanks@us.gt.com.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.
